To amend the Internal Revenue Code of 1986 to curb tax abuses by disallowing tax benefits claimed to arise from transactions without substantial economic substance, and for other purposes.

April 2, 2003

Mr. DOGGETT (for himself, Mr. ALLEN, Ms. BALDWIN, Mr. BECERRA, Mr. CROWLEY, Mr. DEFAZIO, Ms. DELAURO, Mr. FROST, Mr. JEFFERSON, Mrs. JONES of Ohio, Mr. KLECZKA, Mr. LEVIN, Mr. LEWIS of Georgia, Mr. MCDERMOTT, Mr. MCGOVERN, Mr. MCNULTY, Mr. MARKEY, Mr. MATSUI, Mr. GEORGE MILLER of California, Mr. NEAL of Massachusetts, Ms. LORETTA SANCHEZ of California, Mr. SANDERS, Mr. SHERMAN, Ms. SLAUGHTER, Ms. SOLIS, Mr. STARK, Mr. TIERNEY, and Mr. WAXMAN) introduced the following bill; which was referred to the Committee on Ways and Means

To amend the Internal Revenue Code of 1986 to curb tax abuses by disallowing tax benefits claimed to arise from transactions without substantial economic substance, and for other purposes.

Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,

SECTION 1. SHORT TITLE; ETC.

(a) SHORT TITLE- This Act may be cited as the `Abusive Tax Shelter Shutdown and Taxpayer Accountability Act of 2003'.

(b) AMENDMENT OF 1986 CODE- Except as otherwise expressly provided, whenever in this Act an amendment or repeal is expressed in terms of an amendment to, or repeal of, a section or other provision, the reference shall be considered to be made to a section or other provision of the Internal Revenue Code of 1986.

(c) TABLE OF CONTENTS- The table of contents for this Act is as follows:

Sec. 1. Short title; etc.

Sec. 2. Findings and purpose.

TITLE I--PROVISIONS DESIGNED TO CURTAIL TAX SHELTERS

Sec. 101. Clarification of economic substance doctrine.

Sec. 102. Penalty for failing to disclose reportable transaction.

Sec. 103. Accuracy-related penalty for listed transactions and other reportable transactions having a significant tax avoidance purpose.

Sec. 104. Penalty for understatements attributable to transactions lacking economic substance, etc.

Sec. 105. Modifications of substantial understatement penalty for nonreportable transactions.

Sec. 106. Tax shelter exception to confidentiality privileges relating to taxpayer communications.

Sec. 107. Disclosure of reportable transactions.

Sec. 108. Modifications to penalty for failure to register tax shelters.

Sec. 109. Modification of penalty for failure to maintain lists of investors.

Sec. 110. Modification of actions to enjoin certain conduct related to tax shelters and reportable transactions.

Sec. 111. Understatement of taxpayer's liability by income tax return preparer.

Sec. 112. Penalty on failure to report interests in foreign financial accounts.

Sec. 113. Frivolous tax submissions.

Sec. 114. Regulation of individuals practicing before the Department of Treasury.

Sec. 115. Penalty on promoters of tax shelters.

Sec. 116. Statute of limitations for taxable years for which listed transactions not reported.

Sec. 117. Denial of deduction for interest on underpayments attributable to nondisclosed reportable and noneconomic substance transactions.

TITLE II--OTHER PROVISIONS

Sec. 201. Limitation on transfer or importation of built-in losses.

Sec. 202. Disallowance of certain partnership loss transfers.

Sec. 203. No reduction of basis under section 734 in stock held by partnership in corporate partner.

Sec. 204. Repeal of special rules for FASITs.

Sec. 205. Expanded disallowance of deduction for interest on convertible debt.

Sec. 206. Expanded authority to disallow tax benefits under section 269.

Sec. 207. Modifications of certain rules relating to controlled foreign corporations.

Sec. 208. Basis for determining loss always reduced by nontaxed portion of dividends.

Sec. 209. Affirmation of consolidated return regulation authority.

SEC. 2. FINDINGS AND PURPOSE.

(a) FINDINGS- The Congress hereby finds that:

(1) Many corporate tax shelter transactions are complicated ways of accomplishing nothing aside from claimed tax benefits, and the legal opinions justifying those transactions take an inappropriately narrow and restrictive view of well-developed court doctrines under which--

(A) the taxation of a transaction is determined in accordance with its substance and not merely its form,

(B) transactions which have no significant effect on the taxpayer's economic or beneficial interests except for tax benefits are treated as sham transactions and disregarded,

(C) transactions involving multiple steps are collapsed when those steps have no substantial economic meaning and are merely designed to create tax benefits,

(D) transactions with no business purpose are not given effect, and

(E) in the absence of a specific congressional authorization, it is presumed that Congress did not intend a transaction to result in a negative tax where the taxpayer's economic position or rate of return is better after tax than before tax.

(2) Permitting aggressive and abusive tax shelters not only results in large revenue losses but also undermines voluntary compliance with the Internal Revenue Code of 1986.

(b) PURPOSE- The purpose of this Act is to eliminate abusive tax shelters by denying tax attributes claimed to arise from transactions that do not meet a heightened economic substance requirement and by repealing the provision that permits legal opinions to be used to avoid penalties on tax underpayments resulting from transactions without significant economic substance or business purpose.

TITLE I--PROVISIONS DESIGNED TO CURTAIL TAX SHELTERS

SEC. 101. CLARIFICATION OF ECONOMIC SUBSTANCE DOCTRINE.

(a) IN GENERAL- Section 7701 is amended by redesignating subsection (m) as subsection (n) and by inserting after subsection (l) the following new subsection:

`(m) CLARIFICATION OF ECONOMIC SUBSTANCE DOCTRINE; ETC-

`(1) GENERAL RULES-

`(A) IN GENERAL- In applying the economic substance doctrine, the determination of whether a transaction has economic substance shall be made as provided in this paragraph.

`(B) DEFINITION OF ECONOMIC SUBSTANCE- For purposes of subparagraph (A)--

`(i) IN GENERAL- A transaction has economic substance only if--

`(I) the transaction changes in a meaningful way (apart from Federal tax effects and, if there are any Federal tax effects, also apart from any foreign, State, or local tax effects) the taxpayer's economic position, and

`(II) the taxpayer has a substantial nontax purpose for entering into such transaction and the transaction is a reasonable means of accomplishing such purpose.

`(ii) SPECIAL RULE WHERE TAXPAYER RELIES ON PROFIT POTENTIAL- A transaction shall not be treated as having economic substance by reason of having a potential for profit unless--

`(I) the present value of the reasonably expected pre-tax profit from the transaction is substantial in relation to the present value of the expected net tax benefits that would be allowed if the transaction were respected, and

`(II) the reasonably expected pre-tax profit from the transaction exceeds a risk-free rate of return.

`(C) TREATMENT OF FEES AND FOREIGN TAXES- Fees and other transaction expenses and foreign taxes shall be taken into account as expenses in determining pre-tax profit under subparagraph (B)(ii).

`(2) SPECIAL RULES FOR TRANSACTIONS WITH TAX-INDIFFERENT PARTIES-

`(A) SPECIAL RULES FOR FINANCING TRANSACTIONS- The form of a transaction which is in substance the borrowing of money or the acquisition of financial capital directly or indirectly from a tax-indifferent party shall not be respected if the present value of the deductions to be claimed with respect to the transaction is substantially in excess of the present value of the anticipated economic returns of the person lending the money or providing the financial capital. A public offering shall be treated as a borrowing, or an acquisition of financial capital, from a tax-indifferent party if it is reasonably expected that at least 50 percent of the offering will be placed with tax-indifferent parties.

`(B) ARTIFICIAL INCOME SHIFTING AND BASIS ADJUSTMENTS- The form of a transaction with a tax-indifferent party shall not be respected if--

`(i) it results in an allocation of income or gain to the tax-indifferent party in excess of such party's economic income or gain, or

`(ii) it results in a basis adjustment or shifting of basis on account of overstating the income or gain of the tax-indifferent party.

`(3) DEFINITIONS AND SPECIAL RULES- For purposes of this subsection--

`(A) ECONOMIC SUBSTANCE DOCTRINE- The term `economic substance doctrine' means the common law doctrine under which tax benefits under subtitle A with respect to a transaction are not allowable if the transaction does not have economic substance or lacks a business purpose.

`(B) TAX-INDIFFERENT PARTY- The term `tax-indifferent party' means any person or entity not subject to tax imposed by subtitle A. A person shall be treated as a tax-indifferent party with respect to a transaction if the items taken into account with respect to the transaction have no substantial impact on such person's liability under subtitle A.

`(C) SUBSTANTIAL NONTAX PURPOSE- In applying subclause (II) of paragraph (1)(B)(i), a purpose of achieving a financial accounting benefit shall not be taken into account in determining whether a transaction has a substantial nontax purpose if the origin of such financial accounting benefit is a reduction of income tax.

`(D) EXCEPTION FOR PERSONAL TRANSACTIONS OF INDIVIDUALS- In the case of an individual, this subsection shall apply only to transactions entered into in connection with a trade or business or an activity engaged in for the production of income.

`(E) TREATMENT OF LESSORS- In applying subclause (I) of paragraph (1)(B)(ii) to the lessor of tangible property subject to a lease, the expected net tax benefits shall not include the benefits of depreciation, or any tax credit, with respect to the leased property and subclause (II) of paragraph (1)(B)(ii) shall be disregarded in determining whether any of such benefits are allowable.

`(4) OTHER COMMON LAW DOCTRINES NOT AFFECTED- Except as specifically provided in this subsection, the provisions of this subsection shall not be construed as altering or supplanting any other rule of law, and the requirements of this subsection shall be construed as being in addition to any such other rule of law.

`(5) REGULATIONS- The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this subsection. Such regulations may include exemptions from the application of this subsection.'

(b) EFFECTIVE DATE- The amendments made by this section shall apply to transactions entered into after February 13, 2003.

SEC. 102. PENALTY FOR FAILING TO DISCLOSE REPORTABLE TRANSACTION.

(a) IN GENERAL- Part I of subchapter B of chapter 68 (relating to assessable penalties) is amended by inserting after section 6707 the following new section:

`SEC. 6707A. PENALTY FOR FAILURE TO INCLUDE REPORTABLE TRANSACTION INFORMATION WITH RETURN OR STATEMENT.

`(a) IMPOSITION OF PENALTY- Any person who fails to include on any return or statement any information with respect to a reportable transaction which is required under section 6011 to be included with such return or statement shall pay a penalty in the amount determined under subsection (b).

`(b) AMOUNT OF PENALTY-

`(1) IN GENERAL- Except as provided in paragraphs (2) and (3), the amount of the penalty under subsection (a) shall be $50,000.

`(2) LISTED TRANSACTION- The amount of the penalty under subsection (a) with respect to a listed transaction shall be $100,000.

`(3) INCREASE IN PENALTY FOR LARGE ENTITIES AND HIGH NET WORTH INDIVIDUALS-

`(A) IN GENERAL- In the case of a failure under subsection (a) by--

`(i) a large entity, or

`(ii) a high net worth individual,

the penalty under paragraph (1) or (2) shall be twice the amount determined without regard to this paragraph.

`(B) LARGE ENTITY- For purposes of subparagraph (A), the term `large entity' means, with respect to any taxable year, a person (other than a natural person) with gross receipts in excess of $10,000,000 for the taxable year in which the reportable transaction occurs or the preceding taxable year. Rules similar to the rules of paragraph (2) and subparagraphs (B), (C), and (D) of paragraph (3) of section 448(c) shall apply for purposes of this subparagraph.

`(C) HIGH NET WORTH INDIVIDUAL- For purposes of subparagraph (A), the term `high net worth individual' means, with respect to a reportable transaction, a natural person whose net worth exceeds $2,000,000 immediately before the transaction.

`(c) DEFINITIONS- For purposes of this section--

`(1) REPORTABLE TRANSACTION- The term `reportable transaction' means any transaction with respect to which information is required to be included with a return or statement because, as determined under regulations prescribed under section 6011, such transaction is of a type which the Secretary determines as having a potential for tax avoidance or evasion.

`(2) LISTED TRANSACTION- Except as provided in regulations, the term `listed transaction' means a reportable transaction which is the same as, or substantially similar to, a transaction specifically identified by the Secretary as a tax avoidance transaction for purposes of section 6011.

`(d) AUTHORITY TO RESCIND PENALTY-

`(1) IN GENERAL- The Commissioner of Internal Revenue may rescind all or any portion of any penalty imposed by this section with respect to any violation if--

`(A) the violation is with respect to a reportable transaction other than a listed transaction,

`(B) the person on whom the penalty is imposed has a history of complying with the requirements of this title,

`(C) it is shown that the violation is due to an unintentional mistake of fact;

`(D) imposing the penalty would be against equity and good conscience, and

`(E) rescinding the penalty would promote compliance with the requirements of this title and effective tax administration.

`(2) DISCRETION- The exercise of authority under paragraph (1) shall be at the sole discretion of the Commissioner and may be delegated only to the head of the Office of Tax Shelter Analysis. The Commissioner, in the Commissioner's sole discretion, may establish a procedure to determine if a penalty should be referred to the Commissioner or the head of such Office for a determination under paragraph (1).

`(3) NO APPEAL- Notwithstanding any other provision of law, any determination under this subsection may not be reviewed in any administrative or judicial proceeding.

`(4) RECORDS- If a penalty is rescinded under paragraph (1), the Commissioner shall place in the file in the Office of the Commissioner the opinion of the Commissioner or the head of the Office of Tax Shelter Analysis with respect to the determination, including--

`(A) the facts and circumstances of the transaction,

`(B) the reasons for the rescission, and

`(C) the amount of the penalty rescinded.

`(5) REPORT- The Commissioner shall each year report to the Committee on Ways and Means of the House of Representatives and the Committee on Finance of the Senate--

`(A) a summary of the total number and aggregate amount of penalties imposed, and rescinded, under this section, and

`(B) a description of each penalty rescinded under this subsection and the reasons therefor.

`(e) PENALTY REPORTED TO SEC- In the case of a person--

`(1) which is required to file periodic reports under section 13 or 15(d) of the Securities Exchange Act of 1934 or is required to be consolidated with another person for purposes of such reports, and

`(2) which--

`(A) is required to pay a penalty under this section with respect to a listed transaction,

`(B) is required to pay a penalty under section 6662A with respect to any reportable transaction at a rate prescribed under section 6662A(c), or

`(C) is required to pay a penalty under section 6662B with respect to any noneconomic substance transaction,

the requirement to pay such penalty shall be disclosed in such reports filed by such person for such periods as the Secretary shall specify. Failure to make a disclosure in accordance with the preceding sentence shall be treated

as a failure to which the penalty under subsection (b)(2) applies.

`(f) COORDINATION WITH OTHER PENALTIES- The penalty imposed by this section is in addition to any penalty imposed under this title.'.

(b) CONFORMING AMENDMENT- The table of sections for part I of subchapter B of chapter 68 is amended by inserting after the item relating to section 6707 the following:

`Sec. 6707A. Penalty for failure to include reportable transaction information with return or statement.'.

(c) EFFECTIVE DATE- The amendments made by this section shall apply to returns and statements the due date for which is after the date of the enactment of this Act.

SEC. 103. ACCURACY-RELATED PENALTY FOR LISTED TRANSACTIONS AND OTHER REPORTABLE TRANSACTIONS HAVING A SIGNIFICANT TAX AVOIDANCE PURPOSE.

(a) IN GENERAL- Subchapter A of chapter 68 is amended by inserting after section 6662 the following new section:

`SEC. 6662A. IMPOSITION OF ACCURACY-RELATED PENALTY ON UNDERSTATEMENTS WITH RESPECT TO REPORTABLE TRANSACTIONS.

`(a) IMPOSITION OF PENALTY- If a taxpayer has a reportable transaction understatement for any taxable year, there shall be added to the tax an amount equal to 20 percent of the amount of such understatement.

`(b) REPORTABLE TRANSACTION UNDERSTATEMENT- For purposes of this section--

`(1) IN GENERAL- The term `reportable transaction understatement' means the sum of--

`(A) the product of--

`(i) the amount of the increase (if any) in taxable income which results from a difference between the proper tax treatment of an item to which this section applies and the taxpayer's treatment of such item (as shown on the taxpayer's return of tax), and

`(ii) the highest rate of tax imposed by section 1 (section 11 in the case of a taxpayer which is a corporation), and

`(B) the amount of the decrease (if any) in the aggregate amount of credits determined under subtitle A which results from a difference between the taxpayer's treatment of an item to which this section applies (as shown on the taxpayer's return of tax) and the proper tax treatment of such item.

For purposes of subparagraph (A), any reduction of the excess of deductions allowed for the taxable year over gross income for such year, and any reduction in the amount of capital losses which would (without regard to section 1211) be allowed for such year, shall be treated as an increase in taxable income.

`(2) ITEMS TO WHICH SECTION APPLIES- This section shall apply to any item which is attributable to--

`(A) any listed transaction, and

`(B) any reportable transaction (other than a listed transaction) if a significant purpose of such transaction is the avoidance or evasion of Federal income tax.

`(c) HIGHER PENALTY FOR NONDISCLOSED LISTED AND OTHER AVOIDANCE TRANSACTIONS-

`(1) IN GENERAL- Subsection (a) shall be applied by substituting `30 percent' for `20 percent' with respect to the portion of any reportable transaction understatement with respect to which the requirement of section 6664(d)(2)(A) is not met.

`(2) RULES APPLICABLE TO COMPROMISE OF PENALTY-

`(A) IN GENERAL- If the 1st letter of proposed deficiency which allows the taxpayer an opportunity for administrative review in the Internal Revenue Service Office of Appeals has been sent with respect to a penalty to which paragraph (1) applies, only the Commissioner of Internal Revenue may compromise all or any portion of such penalty.

`(B) APPLICABLE RULES- The rules of paragraphs (3), (4), and (5) of section 6707A(d) shall apply for purposes of subparagraph (A).

`(d) DEFINITIONS OF REPORTABLE AND LISTED TRANSACTIONS- For purposes of this section, the terms `reportable transaction' and `listed transaction' have the respective meanings given to such terms by section 6707A(c).

`(e) SPECIAL RULES-

`(1) COORDINATION WITH PENALTIES, ETC., ON OTHER UNDERSTATEMENTS- In the case of an understatement (as defined in section 6662(d)(2))--

`(A) the amount of such understatement (determined without regard to this paragraph) shall be increased by the aggregate amount of reportable transaction understatements and noneconomic substance transaction understatements for purposes of determining whether such understatement is a substantial understatement under section 6662(d)(1), and

`(B) the addition to tax under section 6662(a) shall apply only to the excess of the amount of the substantial understatement (if any) after the application of subparagraph (A) over the aggregate amount of reportable transaction understatements and noneconomic substance transaction understatements.

`(2) COORDINATION WITH OTHER PENALTIES-

`(A) APPLICATION OF FRAUD PENALTY- References to an underpayment in section 6663 shall be treated as including references to a reportable transaction understatement and a noneconomic substance transaction understatement.

`(B) NO DOUBLE PENALTY- This section shall not apply to any portion of an understatement on which a penalty is imposed under section 6662B or 6663.

`(3) SPECIAL RULE FOR AMENDED RETURNS- Except as provided in regulations, in no event shall any tax treatment included with an amendment or supplement to a return of tax be taken into account in determining the amount of any reportable transaction understatement or noneconomic substance transaction understatement if the amendment or supplement is filed after the earlier of the date the taxpayer is first contacted by the Secretary regarding the examination of the return or such other date as is specified by the Secretary.

`(4) NONECONOMIC SUBSTANCE TRANSACTION UNDERSTATEMENT- For purposes of this subsection, the term `noneconomic substance transaction understatement' has the meaning given such term by section 6662B(c).

`(5) CROSS REFERENCE-

(b) DETERMINATION OF OTHER UNDERSTATEMENTS- Subparagraph (A) of section 6662(d)(2) is amended by adding at the end the following flush sentence:

`The excess under the preceding sentence shall be determined without regard to items to which section 6662A applies and without regard to items with respect to which a penalty is imposed by section 6662B.'

(c) REASONABLE CAUSE EXCEPTION-

(1) IN GENERAL- Section 6664 is amended by adding at the end the following new subsection:

`(d) REASONABLE CAUSE EXCEPTION FOR REPORTABLE TRANSACTION UNDERSTATEMENTS-

`(1) IN GENERAL- No penalty shall be imposed under section 6662A with respect to any portion of a reportable transaction understatement if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion.

`(2) SPECIAL RULES- Paragraph (1) shall not apply to any reportable transaction understatement unless--

`(A) the relevant facts affecting the tax treatment of the item are adequately disclosed in accordance with the regulations prescribed under section 6011,

`(B) there is or was substantial authority for such treatment, and

`(C) the taxpayer reasonably believed that such treatment was more likely than not the proper treatment.

A taxpayer failing to adequately disclose in accordance with section 6011 shall be treated as meeting the requirements of subparagraph (A) if the penalty for such failure was rescinded under section 6707A(d).

`(3) RULES RELATING TO REASONABLE BELIEF- For purposes of paragraph (2)(C)--

`(A) IN GENERAL- A taxpayer shall be treated as having a reasonable belief with respect to the tax treatment of an item only if such belief--

`(i) is based on the facts and law that exist at the time the return of tax which includes such tax treatment is filed, and

`(ii) relates solely to the taxpayer's chances of success on the merits of such treatment and does not take into account the possibility that a return will not be audited, such treatment will not be raised on audit, or such treatment will be resolved through settlement if it is raised.

`(B) CERTAIN OPINIONS MAY NOT BE RELIED UPON-

`(i) IN GENERAL- An opinion of a tax advisor may not be relied upon to establish the reasonable belief of a taxpayer if--

`(I) the tax advisor is described in clause (ii), or

`(II) the opinion is described in clause (iii).

`(ii) DISQUALIFIED TAX ADVISORS- A tax advisor is described in this clause if the tax advisor--

`(I) is a material advisor (within the meaning of section 6111(b)(1)) who participates in the organization, management, promotion, or sale of the transaction or who is related (within the meaning of section 267(b) or 707(b)(1)) to any person who so participates,

`(II) is compensated directly or indirectly by a material advisor with respect to the transaction,

`(III) has a fee arrangement with respect to the transaction which is contingent on all or part of the intended tax benefits from the transaction being sustained, or

`(IV) as determined under regulations prescribed by the Secretary, has a continuing financial interest with respect to the transaction.

`(iii) DISQUALIFIED OPINIONS- For purposes of clause (i), an opinion is disqualified if the opinion--

`(I) is based on unreasonable factual or legal assumptions (including assumptions as to future events),

`(II) unreasonably relies on representations, statements, findings, or agreements of the taxpayer or any other person,

`(III) does not identify and consider all relevant facts, or

`(IV) fails to meet any other requirement as the Secretary may prescribe.'

(2) CONFORMING AMENDMENT- The heading for subsection (c) of section 6664 is amended by inserting `FOR UNDERPAYMENTS' after `EXCEPTION'.

(d) CONFORMING AMENDMENTS-

(1) Subparagraph (C) of section 461(i)(3) is amended by striking `section 6662(d)(2)(C)(iii)' and inserting `section 1274(b)(3)(C)'.

(2) Paragraph (3) of section 1274(b) is amended--

(A) by striking `(as defined in section 6662(d)(2)(C)(iii))' in subparagraph (B)(i), and

(B) by adding at the end the following new subparagraph:

`(C) TAX SHELTER- For purposes of subparagraph (B), the term `tax shelter' means--

`(i) a partnership or other entity,

`(ii) any investment plan or arrangement, or

`(iii) any other plan or arrangement,

if a significant purpose of such partnership, entity, plan, or arrangement is the avoidance or evasion of Federal income tax.'

(3) Section 6662(d)(2) is amended by striking subparagraphs (C) and (D).

(4) Section 6664(c)(1) is amended by striking `this part' and inserting `section 6662 or 6663'.

(5) Subsection (b) of section 7525 is amended by striking `section 6662(d)(2)(C)(iii)' and inserting `section 1274(b)(3)(C)'.

(6)(A) The heading for section 6662 is amended to read as follows:

`SEC. 6662. IMPOSITION OF ACCURACY-RELATED PENALTY ON UNDERPAYMENTS.'

(B) The table of sections for part II of subchapter A of chapter 68 is amended by striking the item relating to section 6662 and inserting the following new items:

`Sec. 6662. Imposition of accuracy-related penalty on underpayments.

`Sec. 6662A. Imposition of accuracy-related penalty on understatements with respect to reportable transactions.'

(e) EFFECTIVE DATE- The amendments made by this section shall apply to taxable years ending after the date of the enactment of this Act.

SEC. 104. PENALTY FOR UNDERSTATEMENTS ATTRIBUTABLE TO TRANSACTIONS LACKING ECONOMIC SUBSTANCE, ETC.

(a) IN GENERAL- Subchapter A of chapter 68 is amended by inserting after section 6662A the following new section:

`SEC. 6662B. PENALTY FOR UNDERSTATEMENTS ATTRIBUTABLE TO TRANSACTIONS LACKING ECONOMIC SUBSTANCE, ETC.

`(a) IMPOSITION OF PENALTY- If a taxpayer has an noneconomic substance transaction understatement for any taxable year, there shall be added to the tax an amount equal to 40 percent of the amount of such understatement.

`(b) REDUCTION OF PENALTY FOR DISCLOSED TRANSACTIONS- Subsection (a) shall be applied by substituting `20 percent' for `40 percent' with respect to the portion of any noneconomic substance transaction understatement with respect to which the relevant facts affecting the tax treatment of the item are adequately disclosed in the return or a statement attached to the return.

`(c) NONECONOMIC SUBSTANCE TRANSACTION UNDERSTATEMENT- For purposes of this section--

`(1) IN GENERAL- The term `noneconomic substance transaction understatement' means any amount which would be an understatement under section 6662A(b)(1) if section 6662A were applied by taking into account items attributable to noneconomic substance transactions rather than items to which section 6662A would apply without regard to this paragraph.

`(2) NONECONOMIC SUBSTANCE TRANSACTION- The term `noneconomic substance transaction' means any transaction if--

`(A) there is a lack of economic substance (within the meaning of section 7701(m)(1)) for the transaction giving rise to the claimed tax benefit or the transaction was not respected under section 7701(m)(2), or

`(B) the transaction fails to meet the requirements of any similar rule of law.

`(d) RULES APPLICABLE TO COMPROMISE OF PENALTY-

`(1) IN GENERAL- If the 1st letter of proposed deficiency which allows the taxpayer an opportunity for administrative review in the Internal Revenue Service Office of Appeals has been sent with respect to a penalty to which this section applies, only the Commissioner of Internal Revenue may compromise all or any portion of such penalty.

`(2) APPLICABLE RULES- The rules of paragraphs (3), (4), and (5) of section 6707A(d) shall apply for purposes of paragraph (1).

`(e) COORDINATION WITH OTHER PENALTIES- Except as otherwise provided in this part, the penalty imposed by this section shall be in addition to any other penalty imposed by this title.

`(f) CROSS REFERENCES-

(b) CLERICAL AMENDMENT- The table of sections for part II of subchapter A of chapter 68 is amended by inserting after the item relating to section 6662A the following new item:

`Sec. 6662B. Penalty for understatements attributable to transactions lacking economic substance, etc.'

(c) EFFECTIVE DATE- The amendments made by this section shall apply to transactions entered into after February 13, 2003.

SEC. 105. MODIFICATIONS OF SUBSTANTIAL UNDERSTATEMENT PENALTY FOR NONREPORTABLE TRANSACTIONS.

(a) SUBSTANTIAL UNDERSTATEMENT OF CORPORATIONS- Section 6662(d)(1)(B) (relating to special rule for corporations) is amended to read as follows:

`(B) SPECIAL RULE FOR CORPORATIONS- In the case of a corporation other than an S corporation or a personal holding company (as defined in section 542), there is a substantial understatement of income tax for any taxable year if the amount of the understatement for the taxable year exceeds the lesser of--

`(i) 10 percent of the tax required to be shown on the return for the taxable year (or, if greater, $10,000), or

`(ii) $10,000,000.'

(b) REDUCTION FOR UNDERSTATEMENT OF TAXPAYER DUE TO POSITION OF TAXPAYER OR DISCLOSED ITEM-

(1) IN GENERAL- Section 6662(d)(2)(B)(i) (relating to substantial authority) is amended to read as follows:

`(i) the tax treatment of any item by the taxpayer if the taxpayer had reasonable belief that the tax treatment was more likely than not the proper treatment, or'.

(2) CONFORMING AMENDMENT- Section 6662(d) is amended by adding at the end the following new paragraph:

`(3) SECRETARIAL LIST- For purposes of this subsection, section 6664(d)(2), and section 6694(a)(1), the Secretary may prescribe a list of positions for which the Secretary believes there is not substantial authority or there is no reasonable belief that the tax treatment is more likely than not the

proper tax treatment. Such list (and any revisions thereof) shall be published in the Federal Register or the Internal Revenue Bulletin.'

(c) EFFECTIVE DATE- The amendments made by this section shall apply to taxable years beginning after the date of the enactment of this Act.

SEC. 106. TAX SHELTER EXCEPTION TO CONFIDENTIALITY PRIVILEGES RELATING TO TAXPAYER COMMUNICATIONS.

(a) IN GENERAL- Section 7525(b) (relating to section not to apply to communications regarding corporate tax shelters) is amended to read as follows:

`(b) SECTION NOT TO APPLY TO COMMUNICATIONS REGARDING TAX SHELTERS- The privilege under subsection (a) shall not apply to any written communication which is--

`(1) between a federally authorized tax practitioner and--

`(A) any person,

`(B) any director, officer, employee, agent, or representative of the person, or

`(C) any other person holding a capital or profits interest in the person, and

`(2) in connection with the promotion of the direct or indirect participation of the person in any tax shelter (as defined in section 1274(b)(3)(C)).'

(b) EFFECTIVE DATE- The amendment made by this section shall apply to communications made on or after the date of the enactment of this Act.

SEC. 107. DISCLOSURE OF REPORTABLE TRANSACTIONS.

(a) IN GENERAL- Section 6111 (relating to registration of tax shelters) is amended to read as follows:

`SEC. 6111. DISCLOSURE OF REPORTABLE TRANSACTIONS.

`(a) IN GENERAL- Each material advisor with respect to any reportable transaction shall make a return (in such form as the Secretary may prescribe) setting forth--

`(1) information identifying and describing the transaction,

`(2) information describing any potential tax benefits expected to result from the transaction, and

`(3) such other information as the Secretary may prescribe.

Such return shall be filed not later than the date specified by the Secretary.

`(b) DEFINITIONS- For purposes of this section--

`(1) MATERIAL ADVISOR-

`(A) IN GENERAL- The term `material advisor' means any person--

`(i) who provides any material aid, assistance, or advice with respect to organizing, promoting, selling, implementing, or carrying out any reportable transaction, and

`(ii) who directly or indirectly derives gross income in excess of the threshold amount for such aid, assistance, or advice.

`(B) THRESHOLD AMOUNT- For purposes of subparagraph (A), the threshold amount is--

`(i) $50,000 in the case of a reportable transaction substantially all of the tax benefits from which are provided to natural persons, and

`(ii) $250,000 in any other case.

`(2) REPORTABLE TRANSACTION- The term `reportable transaction' has the meaning given to such term by section 6707A(c).

`(c) REGULATIONS- The Secretary may prescribe regulations which provide--

`(1) that only 1 person shall be required to meet the requirements of subsection (a) in cases in which 2 or more persons would otherwise be required to meet such requirements,

`(2) exemptions from the requirements of this section, and

`(3) such rules as may be necessary or appropriate to carry out the purposes of this section.'

(b) CONFORMING AMENDMENTS-

(1) The item relating to section 6111 in the table of sections for subchapter B of chapter 61 is amended to read as follows:

`Sec. 6111. Disclosure of reportable transactions.'

(2)(A) So much of section 6112 as precedes subsection (c) thereof is amended to read as follows:

`SEC. 6112. MATERIAL ADVISORS OF REPORTABLE TRANSACTIONS MUST KEEP LISTS OF ADVISEES.

`(a) IN GENERAL- Each material advisor (as defined in section 6111) with respect to any reportable transaction (as defined in section 6707A(c)) shall maintain, in such manner as the Secretary may by regulations prescribe, a list--

`(1) identifying each person with respect to whom such advisor acted as such a material advisor with respect to such transaction, and

`(2) containing such other information as the Secretary may by regulations require.

This section shall apply without regard to whether a material advisor is required to file a return under section 6111 with respect to such transaction.'

(B) Section 6112 is amended by redesignating subsection (c) as subsection (b).

(C) Section 6112(b), as redesignated by subparagraph (B), is amended--

(i) by inserting `written' before `request' in paragraph (1)(A), and

(ii) by striking `shall prescribe' in paragraph (2) and inserting `may prescribe'.

(D) The item relating to section 6112 in the table of sections for subchapter B of chapter 61 is amended to read as follows:

`Sec. 6112. Material advisors of reportable transactions must keep lists of advisees.'

(3)(A) The heading for section 6708 is amended to read as follows:

`SEC. 6708. FAILURE TO MAINTAIN LISTS OF ADVISEES WITH RESPECT TO REPORTABLE TRANSACTIONS.'

(B) The item relating to section 6708 in the table of sections for part I of subchapter B of chapter 68 is amended to read as follows:

`Sec. 6708. Failure to maintain lists of advisees with respect to reportable transactions.'

(c) EFFECTIVE DATE- The amendments made by this section shall apply to transactions with respect to which material aid, assistance, or advice referred to in section 6111(b)(1)(A)(i) of the Internal Revenue Code of 1986 (as added by this section) is provided after the date of the enactment of this Act.

SEC. 108. MODIFICATIONS TO PENALTY FOR FAILURE TO REGISTER TAX SHELTERS.

(a) IN GENERAL- Section 6707 (relating to failure to furnish information regarding tax shelters) is amended to read as follows:

`SEC. 6707. FAILURE TO FURNISH INFORMATION REGARDING REPORTABLE TRANSACTIONS.

`(a) IN GENERAL- If a person who is required to file a return under section 6111(a) with respect to any reportable transaction--

`(1) fails to file such return on or before the date prescribed therefor, or

`(2) files false or incomplete information with the Secretary with respect to such transaction,

such person shall pay a penalty with respect to such return in the amount determined under subsection (b).

`(b) AMOUNT OF PENALTY-

`(1) IN GENERAL- Except as provided in paragraph (2), the penalty imposed under subsection (a) with respect to any failure shall be $50,000.

`(2) LISTED TRANSACTIONS- The penalty imposed under subsection (a) with respect to any listed transaction shall be an amount equal to the greater of--

`(A) $200,000, or

`(B) 50 percent of the gross income derived by such person with respect to aid, assistance, or advice which is provided with respect to the reportable transaction before the date the return including the transaction is filed under section 6111.

Subparagraph (B) shall be applied by substituting `75 percent' for `50 percent' in the case of an intentional failure or act described in subsection (a).

`(c) RESCISSION AUTHORITY- The provisions of section 6707A(d) (relating to authority of Commissioner to rescind penalty) shall apply to any penalty imposed under this section.

`(d) REPORTABLE AND LISTED TRANSACTIONS- The terms `reportable transaction' and `listed transaction' have the respective meanings given to such terms by section 6707A(c).'.

(b) CLERICAL AMENDMENT- The item relating to section 6707 in the table of sections for part I of subchapter B of chapter 68 is amended by striking `tax shelters' and inserting `reportable transactions'.

(c) EFFECTIVE DATE- The amendments made by this section shall apply to returns the due date for which is after the date of the enactment of this Act.

SEC. 109. MODIFICATION OF PENALTY FOR FAILURE TO MAINTAIN LISTS OF INVESTORS.

(a) IN GENERAL- Subsection (a) of section 6708 is amended to read as follows:

`(a) IMPOSITION OF PENALTY-

`(1) IN GENERAL- If any person who is required to maintain a list under section 6112(a) fails to make such list available upon written request to the Secretary in accordance with section 6112(b)(1)(A) within 20 business days after the date of the Secretary's request, such person shall pay a penalty of $10,000 for each day of such failure after such 20th day.

`(2) REASONABLE CAUSE EXCEPTION- No penalty shall be imposed by paragraph (1) with respect to the failure on any day if such failure is due to reasonable cause.'

(b) EFFECTIVE DATE- The amendment made by this section shall apply to requests made after the date of the enactment of this Act.

SEC. 110. MODIFICATION OF ACTIONS TO ENJOIN CERTAIN CONDUCT RELATED TO TAX SHELTERS AND REPORTABLE TRANSACTIONS.

(a) IN GENERAL- Section 7408 (relating to action to enjoin promoters of abusive tax shelters, etc.) is amended by redesignating subsection (c) as subsection (d) and by striking subsections (a) and (b) and inserting the following new subsections:

`(a) AUTHORITY TO SEEK INJUNCTION- A civil action in the name of the United States to enjoin any person from further engaging in specified conduct may be commenced at the request of the Secretary. Any action under this section shall be brought in the district court of the United States for the district in which such person resides, has his principal place of business, or has engaged in specified conduct. The court may exercise its jurisdiction over such action (as provided in section 7402(a)) separate and apart from any other action brought by the United States against such person.

`(b) ADJUDICATION AND DECREE- In any action under subsection (a), if the court finds--

`(1) that the person has engaged in any specified conduct, and

`(2) that injunctive relief is appropriate to prevent recurrence of such conduct,

the court may enjoin such person from engaging in such conduct or in any other activity subject to penalty under this title.

`(c) SPECIFIED CONDUCT- For purposes of this section, the term `specified conduct' means any action, or failure to take action, subject to penalty under section 6700, 6701, 6707, or 6708.'

(b) CONFORMING AMENDMENTS-

(1) The heading for section 7408 is amended to read as follows:

`SEC. 7408. ACTIONS TO ENJOIN SPECIFIED CONDUCT RELATED TO TAX SHELTERS AND REPORTABLE TRANSACTIONS.'

(2) The table of sections for subchapter A of chapter 67 is amended by striking the item relating to section 7408 and inserting the following new item:

(c) EFFECTIVE DATE- The amendment made by this section shall take effect on the day after the date of the enactment of this Act.

SEC. 111. UNDERSTATEMENT OF TAXPAYER'S LIABILITY BY INCOME TAX RETURN PREPARER.

(a) STANDARDS CONFORMED TO TAXPAYER STANDARDS- Section 6694(a) (relating to understatements due to unrealistic positions) is amended--

(1) by striking `realistic possibility of being sustained on its merits' in paragraph (1) and inserting `reasonable belief that the tax treatment in such position was more likely than not the proper treatment',

(2) by striking `or was frivolous' in paragraph (3) and inserting `or there was no reasonable basis for the tax treatment of such position', and

(3) by striking `UNREALISTIC' in the heading and inserting `IMPROPER'.

(b) AMOUNT OF PENALTY- Section 6694 is amended--

(1) by striking `$250' in subsection (a) and inserting `$1,000', and

(2) by striking `$1,000' in subsection (b) and inserting `$5,000'.

(c) EFFECTIVE DATE- The amendments made by this section shall apply to documents prepared after the date of the enactment of this Act.

SEC. 112. PENALTY ON FAILURE TO REPORT INTERESTS IN FOREIGN FINANCIAL ACCOUNTS.

(a) IN GENERAL- Section 5321(a)(5) of title 31, United States Code, is amended to read as follows:

`(5) FOREIGN FINANCIAL AGENCY TRANSACTION VIOLATION-

`(A) PENALTY AUTHORIZED- The Secretary of the Treasury may impose a civil money penalty on any person who violates, or causes any violation of, any provision of section 5314.

`(B) AMOUNT OF PENALTY-

`(i) IN GENERAL- Except as provided in subparagraph (C), the amount of any civil penalty imposed under subparagraph (A) shall not exceed $5,000.

`(ii) REASONABLE CAUSE EXCEPTION- No penalty shall be imposed under subparagraph (A) with respect to any violation if--

`(I) such violation was due to reasonable cause, and

`(II) the amount of the transaction or the balance in the account at the time of the transaction was properly reported.

`(C) WILLFUL VIOLATIONS- In the case of any person willfully violating, or willfully causing any violation of, any provision of section 5314--

`(i) the maximum penalty under subparagraph (B)(i) shall be increased to the greater of--

`(I) $25,000, or

`(II) the amount (not exceeding $100,000) determined under subparagraph (D), and

`(ii) subparagraph (B)(ii) shall not apply.

`(D) AMOUNT- The amount determined under this subparagraph is--

`(i) in the case of a violation involving a transaction, the amount of the transaction, or

`(ii) in the case of a violation involving a failure to report the existence of an account or any identifying information required to be provided with respect to an account, the balance in the account at the time of the violation.'

(b) EFFECTIVE DATE- The amendment made by this section shall apply to violations occurring after the date of the enactment of this Act.

SEC. 113. FRIVOLOUS TAX SUBMISSIONS.

(a) CIVIL PENALTIES- Section 6702 is amended to read as follows:

`SEC. 6702. FRIVOLOUS TAX SUBMISSIONS.

`(a) CIVIL PENALTY FOR FRIVOLOUS TAX RETURNS- A person shall pay a penalty of $5,000 if--

`(1) such person files what purports to be a return of a tax imposed by this title but which--

`(A) does not contain information on which the substantial correctness of the self-assessment may be judged, or

`(B) contains information that on its face indicates that the self-assessment is substantially incorrect; and

`(2) the conduct referred to in paragraph (1)--

`(A) is based on a position which the Secretary has identified as frivolous under subsection (c), or

`(B) reflects a desire to delay or impede the administration of Federal tax laws.

`(b) CIVIL PENALTY FOR SPECIFIED FRIVOLOUS SUBMISSIONS-

`(1) IMPOSITION OF PENALTY- Except as provided in paragraph (3), any person who submits a specified frivolous submission shall pay a penalty of $5,000.

`(2) SPECIFIED FRIVOLOUS SUBMISSION- For purposes of this section--

`(A) SPECIFIED FRIVOLOUS SUBMISSION- The term `specified frivolous submission' means a specified submission if any portion of such submission--

`(i) is based on a position which the Secretary has identified as frivolous under subsection (c), or

`(ii) reflects a desire to delay or impede the administration of Federal tax laws.

`(B) SPECIFIED SUBMISSION- The term `specified submission' means--

`(i) a request for a hearing under--

`(I) section 6320 (relating to notice and opportunity for hearing upon filing of notice of lien), or

`(II) section 6330 (relating to notice and opportunity for hearing before levy), and

`(ii) an application under--

`(I) section 6159 (relating to agreements for payment of tax liability in installments),

`(II) section 7122 (relating to compromises), or

`(III) section 7811 (relating to taxpayer assistance orders).

`(3) OPPORTUNITY TO WITHDRAW SUBMISSION- If the Secretary provides a person with notice that a submission is a specified frivolous submission and such person withdraws such submission within 30 days after such notice, the penalty imposed under paragraph (1) shall not apply with respect to such submission.

`(c) LISTING OF FRIVOLOUS POSITIONS- The Secretary shall prescribe (and periodically revise) a list of positions which the Secretary has identified as being frivolous for purposes of this subsection. The Secretary shall not include in such list any position that the Secretary determines meets the requirement of section 6662(d)(2)(B)(ii)(II).

`(d) REDUCTION OF PENALTY- The Secretary may reduce the amount of any penalty imposed under this section if the Secretary determines that such reduction would promote compliance with and administration of the Federal tax laws.

`(e) PENALTIES IN ADDITION TO OTHER PENALTIES- The penalties imposed by this section shall be in addition to any other penalty provided by law.'

(b) TREATMENT OF FRIVOLOUS REQUESTS FOR HEARINGS BEFORE LEVY-

(1) FRIVOLOUS REQUESTS DISREGARDED- Section 6330 (relating to notice and opportunity for hearing before levy) is amended by adding at the end the following new subsection:

`(g) FRIVOLOUS REQUESTS FOR HEARING, ETC- Notwithstanding any other provision of this section, if the Secretary determines that any portion of a request for a hearing under this section or section 6320 meets the requirement of clause (i) or (ii) of section 6702(b)(2)(A), then the Secretary may treat such portion as if it were never submitted and such portion shall not be subject to any further administrative or judicial review.'

(2) PRECLUSION FROM RAISING FRIVOLOUS ISSUES AT HEARING- Section 6330(c)(4) is amended--

(A) by striking `(A)' and inserting `(A)(i)';

(B) by striking `(B)' and inserting `(ii)';

(C) by striking the period at the end of the first sentence and inserting `; or'; and

(D) by inserting after subparagraph (A)(ii) (as so redesignated) the following:

`(B) the issue meets the requirement of clause (i) or (ii) of section 6702(b)(2)(A).'

(3) STATEMENT OF GROUNDS- Section 6330(b)(1) is amended by striking `under subsection (a)(3)(B)' and inserting `in writing under subsection (a)(3)(B) and states the grounds for the requested hearing'.

(c) TREATMENT OF FRIVOLOUS REQUESTS FOR HEARINGS UPON FILING OF NOTICE OF LIEN- Section 6320 is amended--

(1) in subsection (b)(1), by striking `under subsection (a)(3)(B)' and inserting `in writing under subsection (a)(3)(B) and states the grounds for the requested hearing', and

(2) in subsection (c), by striking `and (e)' and inserting `(e), and (g)'.

(d) TREATMENT OF FRIVOLOUS APPLICATIONS FOR OFFERS-IN-COMPROMISE AND INSTALLMENT AGREEMENTS- Section 7122 is amended by adding at the end the following new subsection:

`(e) FRIVOLOUS SUBMISSIONS, ETC- Notwithstanding any other provision of this section, if the Secretary determines that any portion of an application for an offer-in-compromise or installment agreement submitted under this section or section 6159 meets the requirement of clause (i) or (ii) of section 6702(b)(2)(A), then the Secretary may treat such portion as if it were never submitted and such portion shall not be subject to any further administrative or judicial review.'

(e) CLERICAL AMENDMENT- The table of sections for part I of subchapter B of chapter 68 is amended by striking the item relating to section 6702 and inserting the following new item:

`Sec. 6702. Frivolous tax submissions.'

(f) EFFECTIVE DATE- The amendments made by this section shall apply to submissions made and issues raised after the date on which the Secretary first prescribes a list under section 6702(c) of the Internal Revenue Code of 1986, as amended by subsection (a).

SEC. 114. REGULATION OF INDIVIDUALS PRACTICING BEFORE THE DEPARTMENT OF TREASURY.

(a) CENSURE; IMPOSITION OF PENALTY-

(1) IN GENERAL- Section 330(b) of title 31, United States Code, is amended--

(A) by inserting `, or censure,' after `Department', and

(B) by adding at the end the following new flush sentence:

`The Secretary may impose a monetary penalty on any representative described in the preceding sentence. If the representative was acting on behalf of an employer or any firm or other entity in connection with the conduct giving rise to such penalty, the Secretary may impose a monetary penalty on such employer, firm, or entity if it knew, or reasonably should have known, of such conduct. Such penalty shall not exceed the gross income derived (or to be derived) from the conduct giving rise to the penalty and may be in addition to, or in lieu of, any suspension, disbarment, or censure.'

(2) EFFECTIVE DATE- The amendments made by this subsection shall apply to actions taken after the date of the enactment of this Act.

(b) TAX SHELTER OPINIONS, ETC- Section 330 of such title 31 is amended by adding at the end the following new subsection:

`(d) Nothing in this section or in any other provision of law shall be construed to limit the authority of the Secretary of the Treasury to impose standards applicable to the rendering of written advice with respect to any entity, transaction plan or arrangement, or other plan or arrangement, which is of a type which the Secretary determines as having a potential for tax avoidance or evasion.'

SEC. 115. PENALTY ON PROMOTERS OF TAX SHELTERS.

(a) PENALTY ON PROMOTING ABUSIVE TAX SHELTERS- Section 6700(a) is amended by adding at the end the following new sentence: `Notwithstanding the first sentence, if an activity with respect to which a penalty imposed under this subsection involves a statement described in paragraph (2)(A), the amount of the penalty shall be equal to 50 percent of the gross income derived (or to be derived) from such activity by the person on which the penalty is imposed.'

(b) EFFECTIVE DATE- The amendment made by this section shall apply to activities after the date of the enactment of this Act.

SEC. 116. STATUTE OF LIMITATIONS FOR TAXABLE YEARS FOR WHICH LISTED TRANSACTIONS NOT REPORTED.

(a) IN GENERAL- Section 6501(e)(1) (relating to substantial omission of items for income taxes) is amended by adding at the end the following new subparagraph:

`(C) LISTED TRANSACTIONS- If a taxpayer fails to include on any return or statement for any taxable year any information with respect to a listed transaction (as defined in section 6707A(c)(2)) which is required under section 6011 to be included with such return or statement, the tax for such taxable year may be assessed, or a proceeding in court for collection of such tax may be begun without assessment, at any time within 6 years after the time the return is filed. This subparagraph shall not apply to any taxable year if the time for assessment or beginning the proceeding in court has expired before the time a transaction is treated as a listed transaction under section 6011.'

(b) EFFECTIVE DATE- The amendment made by this section shall apply to transactions after the date of the enactment of this Act in taxable years ending after such date.

SEC. 117. DENIAL OF DEDUCTION FOR INTEREST ON UNDERPAYMENTS ATTRIBUTABLE TO NONDISCLOSED REPORTABLE AND NONECONOMIC SUBSTANCE TRANSACTIONS.

(a) IN GENERAL- Section 163 (relating to deduction for interest) is amended by redesignating subsection (m) as subsection (n) and by inserting after subsection (l) the following new subsection:

`(m) INTEREST ON UNPAID TAXES ATTRIBUTABLE TO NONDISCLOSED REPORTABLE TRANSACTIONS AND NONECONOMIC SUBSTANCE TRANSACTIONS- No deduction shall be allowed under this chapter for any interest paid or accrued under section 6601 on any underpayment of tax which is attributable to--

`(1) the portion of any reportable transaction understatement (as defined in section 6662A(b)) with respect to which the requirement of section 6664(d)(2)(A) is not met, or

`(2) any noneconomic substance transaction understatement (as defined in section 6662B(c)).'

(b) EFFECTIVE DATE- The amendments made by this section shall apply to transactions after the date of the enactment of this Act in taxable years ending after such date.

TITLE II--OTHER PROVISIONS

SEC. 201. LIMITATION ON TRANSFER OR IMPORTATION OF BUILT-IN LOSSES.

(a) IN GENERAL- Section 362 (relating to basis to corporations) is amended by adding at the end the following new subsection:

`(e) LIMITATIONS ON BUILT-IN LOSSES-

`(1) LIMITATION ON IMPORTATION OF BUILT-IN LOSSES-

`(A) IN GENERAL- If in any transaction described in subsection (a) or (b) there would (but for this subsection) be an importation of a net built-in loss, the basis of each property described in subparagraph (B) which is acquired in such transaction shall (notwithstanding subsections (a) and (b)) be its fair market value immediately after such transaction.

`(B) PROPERTY DESCRIBED- For purposes of subparagraph (A), property is described in this paragraph if--

`(i) gain or loss with respect to such property is not subject to tax under this subtitle in the hands of the transferor immediately before the transfer, and

`(ii) gain or loss with respect to such property is subject to such tax in the hands of the transferee immediately after such transfer.

In any case in which the transferor is a partnership, the preceding sentence shall be applied by treating each partner in such partnership as holding such partner's proportionate share of the property of such partnership.

`(C) IMPORTATION OF NET BUILT-IN LOSS- For purposes of subparagraph (A), there is an importation of a net built-in loss in

a transaction if the transferee's aggregate adjusted bases of property described in subparagraph (B) which is transferred in such transaction would (but for this paragraph) exceed the fair market value of such property immediately after such transaction.'

`(2) LIMITATION ON TRANSFER OF BUILT-IN LOSSES IN SECTION 351 TRANSACTIONS-

`(A) IN GENERAL- If--

`(i) property is transferred in any transaction which is described in subsection (a) and which is not described in paragraph (1) of this subsection, and

`(ii) the transferee's aggregate adjusted bases of the property so transferred would (but for this paragraph) exceed the fair market value of such property immediately after such transaction,

then, notwithstanding subsection (a), the transferee's aggregate adjusted bases of the property so transferred shall not exceed the fair market value of such property immediately after such transaction.

`(B) ALLOCATION OF BASIS REDUCTION- The aggregate reduction in basis by reason of subparagraph (A) shall be allocated among the property so transferred in proportion to their respective built-in losses immediately before the transaction.

`(C) EXCEPTION FOR TRANSFERS WITHIN AFFILIATED GROUP- Subparagraph (A) shall not apply to any transaction if the transferor owns stock in the transferee meeting the requirements of section 1504(a)(2). In the case of property to which subparagraph (A) does not apply by reason of the preceding sentence, the transferor's basis in the stock received for such property shall not exceed its fair market value immediately after the transfer.'

(b) COMPARABLE TREATMENT WHERE LIQUIDATION- Paragraph (1) of section 334(b) (relating to liquidation of subsidiary) is amended to read as follows:

`(1) IN GENERAL- If property is received by a corporate distributee in a distribution in a complete liquidation to which section 332 applies (or in a transfer described in section 337(b)(1)), the basis of such property in the hands of such distributee shall be the same as it would be in the hands of the transferor; except that the basis of such property in the hands of such distributee shall be the fair market value of the property at the time of the distribution--

`(A) in any case in which gain or loss is recognized by the liquidating corporation with respect to such property, or

`(B) in any case in which the liquidating corporation is a foreign corporation, the corporate distributee is a domestic corporation, and the corporate distributee's aggregate adjusted bases of property described in section 362(e)(1)(B) which is distributed in such liquidation would (but for this subparagraph) exceed the fair market value of such property immediately after such liquidation.'

(c) EFFECTIVE DATE- The amendments made by this section shall apply to transactions after the date of the enactment of this Act.

SEC. 202. DISALLOWANCE OF CERTAIN PARTNERSHIP LOSS TRANSFERS.

(a) TREATMENT OF CONTRIBUTED PROPERTY WITH BUILT-IN LOSS- Paragraph (1) of section 704(c) is amended by striking `and' at the end of subparagraph (A), by striking the period at the end of subparagraph (B) and inserting `, and', and by adding at the end the following:

`(C) if any property so contributed has a built-in loss--

`(i) such built-in loss shall be taken into account only in determining the amount of items allocated to the contributing partner, and

`(ii) except as provided in regulations, in determining the amount of items allocated to other partners, the basis of the contributed property in the hands of the partnership shall be treated as being equal to its fair market value immediately after the contribution.

For purposes of subparagraph (C), the term `built-in loss' means the excess of the adjusted basis of the property (determined without regard to subparagraph (C)(ii)) over its fair market value immediately after the contribution.'

(b) ADJUSTMENT TO BASIS OF PARTNERSHIP PROPERTY ON TRANSFER OF PARTNERSHIP INTEREST IF THERE IS SUBSTANTIAL BUILT-IN LOSS-

(1) ADJUSTMENT REQUIRED- Subsection (a) of section 743 (relating to optional adjustment to basis of partnership property) is amended by inserting before the period `or unless the partnership has a substantial built-in loss immediately after such transfer'.

(2) ADJUSTMENT- Subsection (b) of section 743 is amended by inserting `or with respect to which there is a substantial built-in loss immediately after such transfer' after `section 754 is in effect'.

(3) SUBSTANTIAL BUILT-IN LOSS- Section 743 is amended by adding at the end the following new subsection:

`(d) SUBSTANTIAL BUILT-IN LOSS-

`(1) IN GENERAL- For purposes of this section, a partnership has a substantial built-in loss with respect to a transfer of an interest in a partnership if the transferee partner's proportionate share of the adjusted basis of the partnership property exceeds by more than $250,000 the basis of such partner's interest in the partnership.

`(2) REGULATIONS- The Secretary shall prescribe such regulations as may be appropriate to carry out the purposes of paragraph (1) and section 734(d), including regulations aggregating related partnerships and disregarding property acquired by the partnership in an attempt to avoid such purposes.'

(4) CLERICAL AMENDMENTS-

(A) The section heading for section 743 is amended to read as follows:

`SEC. 743. ADJUSTMENT TO BASIS OF PARTNERSHIP PROPERTY WHERE SECTION 754 ELECTION OR SUBSTANTIAL BUILT-IN LOSS.'

(B) The table of sections for subpart C of part II of subchapter K of chapter 1 is amended by striking the item relating to section 743 and inserting the following new item:

`Sec. 743. Adjustment to basis of partnership property where section 754 election or substantial built-in loss.'

(c) ADJUSTMENT TO BASIS OF UNDISTRIBUTED PARTNERSHIP PROPERTY IF THERE IS SUBSTANTIAL BASIS REDUCTION-

(1) ADJUSTMENT REQUIRED- Subsection (a) of section 734 (relating to optional adjustment to basis of undistributed partnership property) is amended by inserting before the period `or unless there is a substantial basis reduction'.

(2) ADJUSTMENT- Subsection (b) of section 734 is amended by inserting `or unless there is a substantial basis reduction' after `section 754 is in effect'.

(3) SUBSTANTIAL BASIS REDUCTION- Section 734 is amended by adding at the end the following new subsection:

`(d) SUBSTANTIAL BASIS REDUCTION-

`(1) IN GENERAL- For purposes of this section, there is a substantial basis reduction with respect to a distribution if the sum of the amounts described in subparagraphs (A) and (B) of subsection (b)(2) exceeds $250,000.

`(2) REGULATIONS-

(4) CLERICAL AMENDMENTS-

(A) The section heading for section 734 is amended to read as follows:

`SEC. 734. ADJUSTMENT TO BASIS OF UNDISTRIBUTED PARTNERSHIP PROPERTY WHERE SECTION 754 ELECTION OR SUBSTANTIAL BASIS REDUCTION.'

(B) The table of sections for subpart B of part II of subchapter K of chapter 1 is amended by striking the item relating to section 734 and inserting the following new item:

`Sec. 734. Adjustment to basis of undistributed partnership property where section 754 election or substantial basis reduction.'

(d) EFFECTIVE DATES-

(1) SUBSECTION (a)- The amendment made by subsection (a) shall apply to contributions made after the date of the enactment of this Act.

(2) SUBSECTION (b)- The amendments made by subsection (b) shall apply to transfers after the date of the enactment of this Act.

(3) SUBSECTION (c)- The amendments made by subsection (c) shall apply to distributions after the date of the enactment of this Act.

SEC. 203. NO REDUCTION OF BASIS UNDER SECTION 734 IN STOCK HELD BY PARTNERSHIP IN CORPORATE PARTNER.

(a) IN GENERAL- Section 755 is amended by adding at the end the following new subsection:

`(c) NO ALLOCATION OF BASIS DECREASE TO STOCK OF CORPORATE PARTNER- In making an allocation under subsection (a) of any decrease in the adjusted basis of partnership property under section 734(b)--

`(1) no allocation may be made to stock in a corporation which is a partner in the partnership, and

`(2) any amount not allocable to stock by reason of paragraph (1) shall be allocated under subsection (a) to other partnership property.

Gain shall be recognized to the partnership to the extent that the amount required to be allocated under paragraph (2) to other partnership property exceeds the aggregate adjusted basis of such other property immediately before the allocation required by paragraph (2).'

(b) EFFECTIVE DATE- The amendment made by this section shall apply to distributions after the date of the enactment of this Act.

SEC. 204. REPEAL OF SPECIAL RULES FOR FASITS.

(a) IN GENERAL- Part V of subchapter M of chapter 1 (relating to financial asset securitization investment trusts) is hereby repealed.

(b) CONFORMING AMENDMENTS-

(1) Paragraph (6) of section 56(g) is amended by striking `REMIC, or FASIT' and inserting `or REMIC'.

(2) Clause (ii) of section 382(l)(4)(B) is amended by striking `a REMIC to which part IV of subchapter M applies, or a FASIT to which part V of subchapter M applies,' and inserting `or a REMIC to which part IV of subchapter M applies,'.

(3) Paragraph (1) of section 582(c) is amended by striking `, and any regular interest in a FASIT,'.

(4) Subparagraph (E) of section 856(c)(5) is amended by striking the last sentence.

(5) Paragraph (5) of section 860G(a) is amended by adding `and' at the end of subparagraph (B), by striking `, and' at the end of subparagraph (C) and inserting a period, and by striking subparagraph (D).

(6) Subparagraph (C) of section 1202(e)(4) is amended by striking `REMIC, or FASIT' and inserting `or REMIC'.

(7) Subparagraph (C) of section 7701(a)(19) is amended by adding `and' at the end of clause (ix), by striking `, and' at the end of clause (x) and inserting a period, and by striking clause (xi).

(8) The table of parts for subchapter M of chapter 1 is amended by striking the item relating to part V.

(c) EFFECTIVE DATE-

(1) IN GENERAL- Except as provided in paragraph (2), the amendments made by this section shall apply to taxable years beginning after December 31, 2003.

(2) EXCEPTION FOR EXISTING FASITS-

(A) IN GENERAL- Paragraph (1) shall not apply to any FASIT in existence on the date of the enactment of this Act.

(B) TRANSFER OF ADDITIONAL ASSETS NOT PERMITTED- Except as provided in regulations prescribed by the Secretary of the

Treasury or the Secretary's delegate, subparagraph (A) shall cease to apply as of the earliest date after the date of the enactment of this Act that any property is transferred to the FASIT.

SEC. 205. EXPANDED DISALLOWANCE OF DEDUCTION FOR INTEREST ON CONVERTIBLE DEBT.

(a) IN GENERAL- Paragraph (2) of section 163(l) is amended by striking `or a related party' and inserting `or equity held by the issuer (or any related party) in any other person'.

(b) CONFORMING AMENDMENT- Paragraph (3) of section 163(l) is amended by striking `or a related party' in the material preceding subparagraph (A) and inserting `or any other person'.

(c) EFFECTIVE DATE- The amendments made by this section shall apply to debt instruments issued after the date of the enactment of this Act.

SEC. 206. EXPANDED AUTHORITY TO DISALLOW TAX BENEFITS UNDER SECTION 269.

(a) IN GENERAL- Subsection (a) of section 269 (relating to acquisitions made to evade or avoid income tax) is amended to read as follows:

`(a) IN GENERAL- If--

`(1)(A) any person acquires stock in a corporation, or

`(B) any corporation acquires, directly or indirectly, property of another corporation and the basis of such property, in the hands of the acquiring corporation, is determined by reference to the basis in the hands of the transferor corporation, and

`(2) the principal purpose for which such acquisition was made is evasion or avoidance of Federal income tax by securing the benefit of a deduction, credit, or other allowance,

then the Secretary may disallow such deduction, credit, or other allowance.'

(b) EFFECTIVE DATE- The amendment made by this section shall apply to stock and property acquired after February 13, 2003.

SEC. 207. MODIFICATIONS OF CERTAIN RULES RELATING TO CONTROLLED FOREIGN CORPORATIONS.

(a) LIMITATION ON EXCEPTION FROM PFIC RULES FOR UNITED STATES SHAREHOLDERS OF CONTROLLED FOREIGN CORPORATIONS- Paragraph (2) of section 1297(e) (relating to passive investment company) is amended by adding at the end the following flush sentence:

`Such term shall not include any period if there is only a remote likelihood of an inclusion in gross income under section 951(a)(1)(A)(i) of subpart F income of such corporation for such period.'

(b) DETERMINATION OF PRO RATA SHARE OF SUBPART F INCOME- Subsection (a) of section 951 (relating to amounts included in gross income of United States shareholders) is amended by adding at the end the following new paragraph:

`(4) SPECIAL RULES FOR DETERMINING PRO RATA SHARE OF SUBPART F INCOME- The pro rata share under paragraph (2) shall be determined by disregarding--

`(A) any rights lacking substantial economic effect, and

`(B) stock owned by a shareholder who is a tax-indifferent party (as defined in section 7701(m)(3)) if the amount which would (but for this paragraph) be allocated to such shareholder does not reflect such shareholder's economic share of the earnings and profits of the corporation.'

(c) EFFECTIVE DATE- The amendments made by this section shall apply to taxable years on controlled foreign corporation beginning after February 13, 2003, and to taxable years of United States shareholder in which or with which such taxable years of controlled foreign corporations end.

SEC. 208. BASIS FOR DETERMINING LOSS ALWAYS REDUCED BY NONTAXED PORTION OF DIVIDENDS.

(a) IN GENERAL- Section 1059 (relating to corporate shareholder's basis in stock reduced by nontaxed portion of extraordinary dividends) is amended by redesignating subsection (g) as subsection (h) and by inserting after subsection (f) the following new subsection:

`(g) BASIS FOR DETERMINING LOSS ALWAYS REDUCED BY NONTAXED PORTION OF DIVIDENDS- The basis of stock in a corporation (for purposes of determining loss) shall be reduced by the nontaxed portion of any dividend received with respect to such stock if this section does not otherwise apply to such dividend.'

(b) EFFECTIVE DATE- The amendment made by this section shall apply to dividends received after the date of the enactment of this Act.

SEC. 209. AFFIRMATION OF CONSOLIDATED RETURN REGULATION AUTHORITY.

(a) IN GENERAL- Section 1502 (relating to consolidated return regulations) is amended by adding at the end the following new sentence: `In prescribing such regulations, the Secretary may prescribe rules applicable to corporations filing consolidated returns under section 1501 that are different from other provisions of this title that would apply if such corporations filed separate returns.'

(b) RESULT NOT OVERTURNED- Notwithstanding subsection (a), the Internal Revenue Code of 1986 shall be construed by treating Treasury regulation Sec. 1.1502-20(c)(1)(iii) (as in effect on January 1, 2001) as being inapplicable to the type of factual situation in 255 F.3d 1357 (Fed. Cir. 2001).

(c) EFFECTIVE DATE- The provisions of this section shall apply to taxable years beginning before, on, or after the date of the enactment of this Act.

END