To amend the Internal Revenue Code of 1986 to provide additional tax incentives
to encourage economic growth.

February 27, 2003

Mr. NICKLES (for himself and Mr. MILLER) (by request) introduced the following bill; which was read twice and referred to the Committee on Finance

To amend the Internal Revenue Code of 1986 to provide additional tax incentives to encourage economic growth.

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

SECTION 1. SHORT TITLE; REFERENCES; TABLE OF CONTENTS.

(a) SHORT TITLE- This Act may be cited as the `Jobs and Growth Tax 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 of this Act is as follows:

Sec. 1. Short title; references; table of contents.

TITLE I--ACCELERATION OF CERTAIN PREVIOUSLY ENACTED TAX REDUCTIONS; INCREASED EXPENSING FOR SMALL BUSINESSES

Sec. 101. Acceleration of 10-percent individual income tax rate bracket expansion.

Sec. 102. Acceleration of reduction in individual income tax rates.

Sec. 103. Acceleration of 15-percent individual income tax rate bracket expansion for married taxpayers filing joint returns.

Sec. 104. Acceleration of increase in standard deduction for married taxpayers filing joint returns.

Sec. 105. Acceleration of increase in child tax credit.

Sec. 106. Increased expensing for small business.

Sec. 107. Minimum tax relief to individuals.

Sec. 108. Application of EGTRRA sunset to this title.

TITLE II--DIVIDEND EXCLUSION TO ELIMINATE DOUBLE TAXATION OF CORPORATE EARNINGS

Sec. 201. Dividend exclusion to eliminate double taxation of corporate earnings.

Sec. 202. Rules for application of dividend exclusion and retained earnings basis adjustments.

Sec. 203. Treatment of regulated investment companies and real estate investment trusts.

Sec. 204. Treatment of insurance companies.

Sec. 205. Treatment of S corporations.

Sec. 206. Repeal of accumulated earnings tax and personal holding company tax.

Sec. 207. Effective dates.

TITLE I--ACCELERATION OF CERTAIN PREVIOUSLY ENACTED TAX REDUCTIONS; INCREASED EXPENSING FOR SMALL BUSINESSES

SEC. 101. ACCELERATION OF 10-PERCENT INDIVIDUAL INCOME TAX RATE BRACKET EXPANSION.

(a) IN GENERAL- Clause (i) of section 1(i)(1)(B) (relating to the initial bracket amount) is amended by striking `($12,000 in the case of taxable years beginning before January 1, 2008)'.

(b) INFLATION ADJUSTMENT BEGINNING IN 2003- Section 1(i)(1)(C) (relating to inflation adjustment) is amended to read as follows:

`(C) INFLATION ADJUSTMENT- In prescribing the tables under subsection (f) which apply with respect to taxable years beginning in calendar years after 2002--

`(i) the cost-of-living adjustment used in making adjustments to the initial bracket amount shall be determined under subsection (f)(3) by substituting `2001' for `1992' in subparagraph (B) thereof, and

`(ii) such adjustment shall not apply to the amount referred to in subparagraph (B)(iii).

If any amount after adjustment under the preceding sentence is not a multiple of $50, such amount shall be rounded to the next lowest multiple of $50.'.

(c) EFFECTIVE DATE-

(1) IN GENERAL- The amendments made by this section shall apply to taxable years beginning after December 31, 2002.

(2) TABLES FOR 2003- The Secretary of the Treasury shall modify each table which has been prescribed for taxable years beginning in 2003 and which relates to any amendment made by this section, section 102, or section 103 to reflect each such amendment.

SEC. 102. ACCELERATION OF REDUCTION IN INDIVIDUAL INCOME TAX RATES.

(a) IN GENERAL- The table in paragraph (2) of section 1(i) (relating to reductions in rates after June 30, 2001) is amended to read as follows:

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 `In the case of taxable years beginning during calendar year: The corresponding percentages shall be substituted for the following percentages:                     

                                                                                                                                             28%   31%   36%   39.6% 

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                                                          2001                                                                             27.5% 30.5% 35.5%   39.1% 

                                                          2002                                                                             27.0% 30.0% 35.0%   38.6% 

                                           2003 and thereafter                                                                             25.0% 28.0% 33.0% 35.0%'. 

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(b) EFFECTIVE DATE- The amendment made by this section shall apply to taxable years beginning after December 31, 2002.

SEC. 103. ACCELERATION OF 15-PERCENT INDIVIDUAL INCOME TAX RATE BRACKET EXPANSION FOR MARRIED TAXPAYERS FILING JOINT RETURNS.

(a) IN GENERAL- Paragraph (8) of section 1(f) (relating to phaseout of marriage penalty in 15-percent bracket) is amended to read as follows:

`(8) ELIMINATION OF MARRIAGE PENALTY IN 15-PERCENT BRACKET- With respect to taxable years beginning after December 31, 2002, in prescribing the tables under paragraph (1)--

`(A) the maximum taxable income in the 15 percent rate bracket in the table contained in subsection (a) (and the minimum taxable income in the next higher taxable income bracket in such table) shall be 200 percent of the maximum taxable income in the 15-percent rate bracket in the table contained in subsection (c) (after any other adjustment under this subsection), and

`(B) the comparable taxable income amounts in the table contained in subsection

(d) shall be 1/2 of the amounts determined under subparagraph (A).'.

(b) CONFORMING AMENDMENTS-

(1) The heading for subsection (f) of section 1 is amended by striking `PHASEOUT' and inserting `ELIMINATION'.

(2) Section 302(c) of the Economic Growth and Tax Relief Reconciliation Act of 2001 is amended by striking `2004' and inserting `2002'.

(c) EFFECTIVE DATE- The amendments made by this section shall apply to taxable years beginning after December 31, 2002.

SEC. 104. ACCELERATION OF INCREASE IN STANDARD DEDUCTION FOR MARRIED TAXPAYERS FILING JOINT RETURNS.

(a) IN GENERAL- Paragraph (2) of section 63(c) (relating to basic standard deduction) is amended to read as follows:

`(2) BASIC STANDARD DEDUCTION- For purposes of paragraph (1), the basic standard deduction is--

`(A) 200 percent of the dollar amount in effect under subparagraph (C) for the taxable year in the case of--

`(i) a joint return, or

`(ii) a surviving spouse (as defined in section 2(a)),

`(B) $4,400 in the case of a head of household (as defined in section 2(b)), or

`(C) $3,000 in any other case.'.

(b) CONFORMING AMENDMENTS-

(1) Section 63(c)(4) is amended by striking `(2)(D)' each place it occurs and inserting `(2)(C)'.

(2) Section 63(c) is amended by striking paragraph (7).

(3) Section 301(d) of the Economic Growth and Tax Relief Reconciliation Act of 2001 is amended by striking `2004' and inserting `2002'.

(c) EFFECTIVE DATE- The amendments made by this section shall apply to taxable years beginning after December 31, 2002.

SEC. 105. ACCELERATION OF INCREASE IN CHILD TAX CREDIT.

(a) IN GENERAL- Subsection (a) of section 24 (relating to child tax credit) is amended to read as follows:

`(a) ALLOWANCE OF CREDIT- There shall be allowed as a credit against the tax imposed by this chapter for the taxable year with respect to each qualifying child of the taxpayer an amount equal to $1,000.'.

(b) ADVANCE PAYMENT OF PORTION OF INCREASED CREDIT IN 2003-

(1) IN GENERAL- Subchapter B of chapter 65 (relating to abatements, credits, and refunds) is amended by adding at the end the following new section:

`SEC. 6429. ADVANCE PAYMENT OF PORTION OF INCREASED CHILD CREDIT.

`(a) IN GENERAL- Each eligible taxpayer shall be treated as having made a payment against the tax imposed by chapter 1 for such taxpayer's first taxable year beginning in 2002 in an amount equal to the child tax credit refund amount.

`(b) ELIGIBLE TAXPAYER- For purposes of this section, the term `eligible taxpayer' means any taxpayer if--

`(1) such taxpayer was allowed a credit under section 24 for such taxpayer's first taxable year beginning in 2002, and

`(2) at least one qualifying child (as defined in section 24(c)) of the taxpayer for such year meets the age requirement for 2003.

`(c) CHILD TAX CREDIT REFUND AMOUNT-

`(1) IN GENERAL- For purposes of this section, the child tax credit refund amount is equal to the excess (if any) of--

`(A) the amount which would have been allowed as a credit under section 24 for the taxpayer's first taxable year beginning in 2002 if--

`(i) the per child amount for such year were $1,000, and

`(ii) only qualifying children (as defined in section 24(c)) of the taxpayer for such year who meet the age requirement for 2003 were taken into account, over

`(B) the amount which would have been allowed as a credit under section 24 for the taxpayer's first taxable year beginning in 2002 if only qualifying children (as defined in section 24(c)) of the taxpayer for such year who meet the age requirement for 2003 were taken into account.

`(2) ADJUSTMENTS- The amounts described in subparagraphs (A) and (B) of paragraph (1) shall be determined--

`(A) without regard to section 24(d)(1)(B)(ii), and

`(B) as if the credit allowed under section 24(d) were allowed under section 24.

`(d) AGE REQUIREMENT- A child of a taxpayer meets the age requirement for 2003 if such child meets the requirement of section 24(c)(1)(B) for the taxpayer's first taxable year beginning in 2003.

`(e) TIMING OF PAYMENTS- In the case of any overpayment attributable to this section, the Secretary shall, subject to the provisions of this title, refund or credit such overpayment as rapidly as possible and, to the extent practicable, before December 31, 2003.

`(f) COORDINATION WITH CHILD TAX CREDIT-

`(1) IN GENERAL- The amount of credit which would (but for this paragraph) be allowable under section 24 for the taxpayer's first taxable year beginning in 2003 shall be reduced (but not below zero) by the aggregate refunds and credits made or allowed to the taxpayer under this section. Any failure to so reduce the credit shall be treated as arising out of a mathematical or clerical error and assessed according to section 6213(b)(1).

`(2) JOINT RETURNS- In the case of a refund or credit made or allowed under this section with respect to a joint return, half of such refund or credit

shall be treated as having been made or allowed to each individual filing such return.

`(g) NO INTEREST- No interest shall be allowed on any overpayment attributable to this section.'.

(2) CLERICAL AMENDMENT- The table of sections for subchapter B of chapter 65 is amended by adding at the end the following new item:

(c) EFFECTIVE DATES-

(1) SUBSECTION (a)- The amendment made by subsection (a) shall apply to taxable years beginning after December 31, 2002.

(2) SUBSECTION (b)- The amendments made by subsection (b) shall take effect on the date of the enactment of this Act.

SEC. 106. INCREASED EXPENSING FOR SMALL BUSINESS.

(a) IN GENERAL- Paragraph (1) of section 179(b) (relating to dollar limitation) is amended to read as follows:

`(1) DOLLAR LIMITATION- The aggregate cost which may be taken into account under subsection (a) for any taxable year shall not exceed $75,000.'.

(b) INCREASE IN QUALIFYING INVESTMENT AT WHICH PHASEOUT BEGINS- Paragraph (2) of section 179(b) (relating to reduction in limitation) is amended by striking `$200,000' and inserting `$325,000'.

(c) OFF-THE-SHELF COMPUTER SOFTWARE- Paragraph (1) of section 179(d) (defining section 179 property) is amended to read as follows:

`(1) SECTION 179 PROPERTY- For purposes of this section, the term `section 179 property' means property--

`(A) which is--

`(i) tangible property (to which section 168 applies), or

`(ii) computer software (as defined in section 197(e)(3)(B)) which is described in section 197(e)(3)(A)(i) and to which section 167 applies,

`(B) which is section 1245 property (as defined in section 1245(a)(3)), and

`(C) which is acquired by purchase for use in the active conduct of a trade or business.

Such term shall not include any property described in section 50(b) and shall not include air conditioning or heating units.'.

(d) ADJUSTMENT OF DOLLAR LIMIT AND PHASEOUT THRESHOLD FOR INFLATION- Subsection (b) of section 179 (relating to limitations) is amended by adding at the end the following new paragraph:

`(5) INFLATION ADJUSTMENTS-

`(A) IN GENERAL- In the case of any taxable year beginning in a calendar year after 2003, the dollar amounts in paragraphs (1) and (2) shall each be increased by an amount equal to--

`(i) such dollar amount, multiplied by

`(ii) the cost-of-living adjustment determined under section 1(f)(3) for the calendar year in which the taxable year begins, by substituting `calendar year 2002' for `calendar year 1992' in subparagraph (B) thereof.

`(B) ROUNDING-

`(i) DOLLAR LIMITATION- If the amount in paragraph (1) as increased under subparagraph (A) is not a multiple of $1,000, such amount shall be rounded to the nearest multiple of $1,000.

`(ii) PHASEOUT AMOUNT- If the amount in paragraph (2) as increased under subparagraph (A) is not a multiple of $10,000, such amount shall be rounded to the nearest multiple of $10,000.'.

(e) REVOCATION OF ELECTION- Paragraph (2) of section 179(c) (relating to election irrevocable) is amended to read as follows:

`(2) REVOCATION OF ELECTION- The taxpayer may revoke an election under paragraph (1), and any specification contained in any such election, with respect to any property. Such revocation, once made, shall be irrevocable.'.

(f) EFFECTIVE DATE- The amendments made by this section shall apply to taxable years beginning after December 31, 2002.

SEC. 107. MINIMUM TAX RELIEF TO INDIVIDUALS.

(a) IN GENERAL- So much of paragraph (1) of section 55(d) (relating to exemption amount for taxpayers other than corporations) as precedes subparagraph (C) thereof is amended to read as follows:

`(1) EXEMPTION AMOUNT FOR TAXPAYERS OTHER THAN CORPORATIONS- In the case of a taxpayer other than a corporation, the term `exemption amount' means as follows:

`(A) JOINT RETURN AND SURVIVING SPOUSE- In the case of a joint return or a surviving spouse, the amount under the following table:

The exemption amount is:

Before 2001

--$45,000

In 2001 and 2002

--$49,000

In 2003, 2004, and 2005

--$57,000

After 2005

--$45,000.

`(B) INDIVIDUAL NOT MARRIED AND NOT A SURVIVING SPOUSE- In the case of an individual who is not a married individual and is not a surviving spouse, the amount under the following table:

The exemption amount is:

Before 2001

--$33,750

In 2001 and 2002

--$35,750

In 2003, 2004, and 2005

--$39,750

After 2005

--$33,750.'.

(b) CONFORMING AMENDMENTS-

(1) Section 55(d)(1)(C) is amended--

(A) by striking `, and' and inserting a period, and

(B) by striking `50 percent' and inserting `MARRIED INDIVIDUAL FILING A SEPARATE RETURN- 50 percent'.

(2) Section 55(d)(1)(D) is amended by striking `$22,500' and inserting `ESTATE AND TRUST- $22,500'.

(c) EFFECTIVE DATE- The amendments made by this section shall apply to taxable years beginning after December 31, 2002.

SEC. 108. APPLICATION OF EGTRRA SUNSET TO THIS TITLE.

Each amendment made by this title (other than section 106) shall be subject to title IX of the Economic Growth and Tax Relief Reconciliation Act of 2001 to the same extent and in the same manner as the provision of such Act to which such amendment relates.

TITLE II--DIVIDEND EXCLUSION TO ELIMINATE DOUBLE TAXATION OF CORPORATE EARNINGS

SEC. 201. DIVIDEND EXCLUSION TO ELIMINATE DOUBLE TAXATION OF CORPORATE EARNINGS.

(a) IN GENERAL- Part III of subchapter B of chapter 1 is amended by inserting after section 115 the following new section:

`SEC. 116. DIVIDEND EXCLUSION TO ELIMINATE DOUBLE TAXATION OF CORPORATE EARNINGS.

`(a) EXCLUSION- Gross income does not include the excludable portion (as defined in section 281) of any amount received as a dividend.

`(b) COMPARABLE TREATMENT FOR RETAINED EARNINGS- If the excludable dividend amount (as defined in section 281) of any corporation for any calendar year exceeds the dividends paid by the corporation in such calendar year, the basis of stock in the corporation shall be increased in the manner and to the extent provided in section 282.

`(c) REPORTING TO SHAREHOLDERS- For reporting to shareholders, see section 6042.'

(b) CLERICAL AMENDMENT- The table of sections for such part III is amended by inserting after the item relating to section 115 the following new item:

`Sec. 116. Dividend exclusion to eliminate double taxation of corporate earnings.'

SEC. 202. RULES FOR APPLICATION OF DIVIDEND EXCLUSION AND RETAINED EARNINGS BASIS ADJUSTMENTS.

(a) IN GENERAL- Subchapter B of chapter 1 (as amended by subsection (d)) is amended by inserting after part IX the following new part:

`PART X--RULES FOR APPLICATION OF DIVIDEND EXCLUSION AND RETAINED EARNINGS BASIS ADJUSTMENTS.

`Sec. 281. Excludable portion of dividends.

`Sec. 282. Retained earnings basis adjustments.

`Sec. 283. Treatment of distributions after previous retained earnings basis adjustments.

`Sec. 284. Special rules for credits and refunds.

`Sec. 285. Special rules for foreign corporations and shareholders.

`Sec. 286. Other special rules.

`Sec. 287. Regulations.

`SEC. 281. EXCLUDABLE PORTION OF DIVIDENDS.

`(a) EXCLUDABLE PORTION- For purposes of section 116, the term `excludable portion' means, with respect to any dividend paid by a corporation in a calendar year, an amount which bears the same ratio to such dividend as the excludable dividend amount of such corporation for the calendar year bears to the total amount of dividends paid by such corporation in such calendar year.

`(b) EXCLUDABLE DIVIDEND AMOUNT- For purposes of this part and section 116--

`(1) IN GENERAL- The term `excludable dividend amount' means, with respect to any corporation for any calendar year, the excess of--

`(A) the sum of--

`(i) the fully taxed earnings amount for the preceding calendar year,

`(ii) the aggregate amount of dividends received by the corporation during such preceding year which are excluded from gross income under section 116(a), and

`(iii) the aggregate amount of increases during such preceding year under section 116(b) in the basis of stock held by the corporation, over

`(B) the amount of applicable income tax taken into account under subparagraph (A)(i).

`(2) CARRYOVER OF EXCESS OF EXCLUDABLE DIVIDEND AMOUNT OVER EARNINGS AND PROFITS- The excludable dividend amount of a corporation for any calendar year shall be increased by the excess of--

`(A) the excludable dividend amount of such corporation for the preceding calendar year, over

`(B) the maximum amount which could have been paid by the corporation as dividends during such preceding calendar year.

`(c) FULLY TAXED EARNINGS AMOUNT-

`(1) IN GENERAL- The fully taxed earnings amount for any calendar year is the amount of the applicable income tax shown on applicable returns for such year divided by the highest rate of tax specified in section 11.

`(2) INCREASE FOR PRIOR YEAR ASSESSMENTS- The fully taxed earnings amount for any calendar year shall be increased by the amount of any applicable income tax (not previously taken into account under paragraph (1)) which is assessed during such year divided by the highest rate of tax specified in section 11.

`(3) LIMITATION TO AMOUNT PAID- If an amount described in paragraph (1) or (2) is paid after the close of the calendar year in which such amount would (but for this paragraph) be taken into account, such amount shall be taken into account for the calendar year in which paid.

`(4) HIGHEST RATE OF TAX- For purposes of this subsection, the highest rate of tax specified in section 11 with respect to any applicable income tax shall be such highest rate for the taxable year for which (or by reference to which) such tax is determined.

`(d) DEFINITIONS- For purposes of this part--

`(1) APPLICABLE INCOME TAX-

`(A) IN GENERAL- The term `applicable income tax' means the excess (if any) of--

`(i) the sum of the taxes imposed by sections 11, 55, 511, 801, 831, 882, 1201, 1291 (without regard to section 1291(c)(1)(B)), and 1374, over

`(ii) the sum of the credits under part IV of subchapter A (other than subpart C and section 27(a)).

`(B) TRANSITIONAL RULES-

`(i) IN GENERAL- Such term shall not include any tax imposed for any taxable year ending before April 1, 2001.

`(ii) TREATMENT OF MINIMUM TAX CREDIT- The applicable income tax shall not be reduced by the credit under section 53 attributable (determined as if such credit were used on a first-in first-out basis) to taxable years ending before April 1, 2001.

`(iii) SECTION 1374- The reference to section 1374 in subparagraph (A)(i) shall not apply to taxable years beginning before January 1, 2003.

`(iv) OTHER TAXES INCLUDED- The taxes imposed by sections 531 and 541 (as in effect before their repeal) shall be taken into account under subparagraph (A)(i) for taxable years ending after March 30, 2001, and beginning before January 1, 2003.

`(2) APPLICABLE RETURN-

`(A) IN GENERAL- The term `applicable return' means, with respect to a calendar year, any return of applicable income tax for a taxable year if the 15th day of the 8th month following the close of such taxable year occurs during such calendar year.

`(B) FILING REQUIREMENT- If a return is filed after the close of the calendar year with respect to which such return would (but for this subparagraph) be treated as an applicable return under subparagraph (A), such return shall be treated as an applicable return for the calendar year in which filed.

`SEC. 282. RETAINED EARNINGS BASIS ADJUSTMENTS.

`(a) IN GENERAL- If any portion of the excess described in section 116(b) is allocated to a share of stock in a corporation under subsection (b), the basis of such share shall be increased by the amount so allocated.

`(b) ALLOCATION OF EXCESS-

`(1) IN GENERAL- A corporation may allocate the excess described in section 116(b) for any calendar year to shares of stock in the corporation at 1 or more times during the calendar year to the extent that cash in the amount of such excess, if distributed at the time of such allocation, would be a dividend.

`(2) MANNER- Except as provided in regulations prescribed by the Secretary, any amount allocated under paragraph (1) shall be allocated in the same manner as if cash in such amount were actually distributed as dividends. No allocation shall be effective before the date on which it is made by the corporation.

`(3) EXCEPTION FOR CERTAIN PREFERRED STOCK- No amount may be allocated under this subsection to stock described in section 1504(a)(4) (determined without regard to subparagraph (A) thereof).

`(c) EFFECT ON EARNINGS AND PROFITS- Earnings and profits of a corporation making an allocation under subsection (b), and of a corporation receiving such an allocation, shall be adjusted in the same manner as if the allocation were treated as a dividend.

`(d) AUTHORITY TO ALLOW CARRYOVER OF UNALLOCATED EXCESS EXCLUDABLE DIVIDEND AMOUNT- Notwithstanding section 281, the Secretary may by regulation allow a corporation to increase the excludable dividend amount for any calendar year by the amount of the excess described in section 116(b) for the preceding calendar year which is not allocated under subsection (b).

`SEC. 283. TREATMENT OF DISTRIBUTIONS AFTER PREVIOUS RETAINED EARNINGS BASIS ADJUSTMENTS.

`(a) TREATMENT OF DISTRIBUTIONS-

`(1) IN GENERAL- If a corporation makes distributions described in section 301(a) with respect to any class of stock in any calendar year which are not excludable under section 116(a), such distributions shall not be treated as dividends (and paragraphs (2) and (3) of section 301(c) shall apply to such distributions) to the extent such distributions do not exceed the corporation's cumulative retained earnings basis adjustment amount for such class as of the beginning of such year. If such distributions exceed such amount, this paragraph shall be applied to a proportionate share of each such distribution.

`(2) SPECIAL RULES FOR RECHARACTERIZED DIVIDENDS- If any dividend (determined without regard to this subsection) during any calendar year with respect to any class of stock in a corporation is treated as a distribution other than a dividend under paragraph (1), such treatment shall be disregarded for purposes of--

`(A) determining the excludable portion under section 281 of dividends paid by the corporation during the calendar year, and

`(B) determining whether any distribution during the calendar year with respect to stock in the corporation is treated as a dividend.

`(b) CUMULATIVE RETAINED EARNINGS BASIS ADJUSTMENT AMOUNT- For purposes of this section, the term `cumulative retained earnings basis adjustment amount' means, with respect to any class of stock for any calendar year, the excess (if any) of--

`(1) the aggregate of the excess described in section 116(b) allocated to shares of such class of stock under section 282 for all preceding calendar years, over

`(2) the aggregate amount of distributions to which subsection (a)(1) applies with respect to such class of stock for all preceding calendar years.

`SEC. 284. SPECIAL RULES FOR CREDITS AND REFUNDS.

`(a) IN GENERAL- No overpayment of an applicable income tax may be allowed as a credit or refund to the extent that the overpayment exceeds the sum of--

`(1) the aggregate applicable income taxes for the calendar year in which the credit or refund would otherwise be allowed or made, and

`(2) an amount equal to the lesser of--

`(A) the product of the corporation's excludable dividend amount for such calendar year and the fraction the numerator of which is the highest rate of tax specified in section 11 (within the meaning of section 281(c)(4)) and

the denominator of which is 1 minus such highest rate, or

`(B) the amount specified by the corporation for purposes of this paragraph.

`(b) ADJUSTMENTS TO EXCLUDABLE DIVIDEND AMOUNTS RESULTING FROM CREDITS AND REFUNDS- If subsection (a) applies to any credit or refund which is allowed or made in a calendar year--

`(1) the applicable income taxes described in subsection (a)(1) otherwise taken into account under section 281 for determining the excludable dividend amount for the succeeding calendar year shall be reduced (but not below zero) by the amount of the credit or refund, and

`(2) the excludable dividend amount for the calendar year shall be reduced by the excess of--

`(A) the amount determined under subsection (a)(2) divided by the highest rate of tax specified in section 11, over

`(B) the amount determined under subsection (a)(2).

`(c) DISALLOWED OVERPAYMENT NOT LOST- Nothing in subsection (a) shall be construed to reduce the amount of any overpayment for which credit or refund is not allowed by reason of subsection (a), and such overpayment shall continue to be taken into account in applying subsection (a) for succeeding calendar years until a credit or refund is allowed or made.

`(d) EXCEPTION FOR FOREIGN TAX CREDIT- This section shall not apply to any overpayment to the extent that such overpayment is attributable to the credit allowed under section 27(a).

`(e) DENIAL OF INTEREST- No interest shall be allowed on any overpayment during the period that credit or refund of such overpayment is not allowed by reason of this section.

`SEC. 285. SPECIAL RULES FOR FOREIGN CORPORATIONS AND SHAREHOLDERS.

`(a) COMPUTATION OF EXCLUDABLE DIVIDEND AMOUNTS OF FOREIGN CORPORATIONS-

`(1) REDUCTION IN EXCLUDABLE DIVIDEND AMOUNT FOR CERTAIN TAXES- The reduction under section 281(b)(1)(B) (without regard to this subparagraph) shall be increased by the sum of--

`(A) the taxes imposed by section 884 (relating to branch profits tax), and

`(B) so much of the taxes imposed by section 881 as are attributable to dividends which would (but for subsection (b)) be excludable under section 116 or are attributable to distributions which are described in section 283(a).

`(2) TREATMENT OF DISALLOWED EXCLUSIONS AND ADJUSTMENTS- Notwithstanding subsection (b)--

`(A) the excludable dividend amount of a foreign corporation for a calendar year shall be increased by--

`(i) the dividends received by the corporation which (but for subsection (b)) would be excludable under section 116(a), and

`(ii) the distributions received by such corporation during such year which are described in section 283(a), and

`(B) the earnings and profits of a foreign corporation--

`(i) shall be increased by the amount described in subparagraph (A)(ii), and

`(ii) shall not be increased by any excess described in section 116(b) allocated to such corporation for which an increase in basis is not allowed by reason of subsection (b)(2).

`(b) TAXATION OF FOREIGN SHAREHOLDERS- In the case of a shareholder who is a nonresident alien individual or a foreign corporation--

`(1) no dividends shall be excludable under section 116(a),

`(2) there shall be no increase in basis for any excess described in section 116(b) allocated to such individual or corporation under section 282, and

`(3) any distribution described in section 283 shall be treated as a dividend for purposes of sections 871 and 881 and chapter 3.

`(c) RULES RELATING TO FOREIGN TAX CREDIT-

`(1) IN GENERAL- No credit shall be allowed under section 901 for any taxes paid or accrued (or deemed paid under section 902 or 960) with respect to any dividend excludable under section 116 and any distribution described in section 283(a).

`(2) EXCLUDABLE DIVIDEND AMOUNT- The excludable dividend amount of a corporation for any calendar year shall be determined without regard to a reduction in the credit allowed by section 27(a) on an applicable return for a prior calendar year.

`SEC. 286. OTHER SPECIAL RULES.

`(a) REDEMPTIONS- If a corporation makes a distribution to a shareholder during any calendar year with respect to its stock and section 301 does not apply to such distribution, the excludable dividend amount for the calendar year, and the cumulative retained earnings basis adjustment amount as of the beginning of the calendar year in which the distribution is made, shall be reduced by the ratable share of such amounts attributable to the stock so redeemed.

`(b) COORDINATION WITH SECTION 246(c)-

`(1) HOLDING PERIOD REQUIREMENTS- If a shareholder disposes of any share of stock before the holding period requirements of section 246(c) are met--

`(A) the basis of such share shall be reduced by the amount of dividends received with respect to such share which are excludable under section 116(a), and

`(B) there shall be no increase in basis for any excess described in section 116(b) allocated to the shareholder of such stock under section 282.

`(2) RELATED PAYMENTS- No deduction shall be allowed under this chapter for any related payments described in section 246(c)(1)(B) with respect to any dividend excludable under section 116(a) or basis increase under section 116(b) with respect to

any share of stock to the extent that such payments do not exceed the amount of such dividend or basis increase.

`(3) TREATMENT OF DISALLOWED EXCLUSIONS AND ADJUSTMENTS- The excludable dividend amount of any corporation for a calendar year, and its earnings and profits, shall not be increased by--

`(A) the dividends received by the corporation which are excludable under section 116(a) and which resulted in a basis reduction under paragraph (1)(A), and

`(B) the aggregate increases in basis which (but for paragraph (1)(B)) would be made in stock held by the corporation.

`(c) TREATMENT OF REGULATED INVESTMENT COMPANIES AND REAL ESTATE INVESTMENT TRUSTS-

`(1) IN GENERAL- Except as provided in regulations, the excludable dividend amount of a regulated investment company or real estate investment trust shall be zero.

`(2) CROSS REFERENCE-

`(d) EXCLUSION AND BASIS ALLOCATION REDUCED WHERE PORTFOLIO STOCK HELD BY CORPORATION IS DEBT-FINANCED-

`(1) TREATMENT OF EXCLUDABLE DIVIDEND- In the case of any debt-financed portfolio stock (within the meaning of section 246A), the amount excluded under section 116(a) with respect to any dividend received with respect to such stock shall be an amount equal to the product of--

`(A) the amount which would be excluded under section 116(a) without regard to this paragraph, and

`(B) 100 percent minus the average indebtedness percentage (within the meaning of section 246A(d)).

`(2) TREATMENT OF BASIS INCREASE- In the case of any debt-financed portfolio stock (within the meaning of section 246A) with respect to which there is an increase in basis under section 116(b) during any taxable year, the gross income of the taxpayer shall be increased by an amount equal to the product of--

`(A) the amount of the increase under section 116(b), and

`(B) the average indebtedness percentage (within the meaning of section 246A(d)).

`(3) LIMITATION- The aggregate amount of reductions under paragraph (1) and increases in gross income under paragraph (2) with respect to any debt-financed portfolio stock shall not exceed the amount of interest deduction (including any deductible short sale expense) allocable to such stock.

`(4) TREATMENT OF INCREASE IN GROSS INCOME- The excludable dividend amount of a corporation for a calendar year shall not be increased by reason of any increase in gross income under paragraph (2).

`(5) EXCEPTION- This subsection shall not apply to any dividend described in paragraph (1) or (2) of section 246A(b).

`(e) COOPERATIVES- In the case of a cooperative to which subchapter T applies--

`(1) the excludable dividend amount of such cooperative shall be allocated for purposes of section 116 and this part between shares of such cooperative held by patrons and shares held by other persons in such manner as the Secretary shall prescribe by regulations, and

`(2) no deduction shall be allowed to the cooperative under this chapter for any dividend paid to a patron which is excludable under section 116(a) or for any distribution described in section 283(a) which reduced the basis of stock held by the cooperative under section 301(c)(2).

`(f) ESOP STOCK- Any dividend allowed as a deduction under section 404(k) shall not be treated as a dividend for purposes of section 116 and this part, and any stock with respect to which such a dividend may be paid shall not be taken into account in making any allocation under 282 or any distribution described in section 283(a).

`SEC. 287. REGULATIONS.

`The Secretary shall prescribe such regulations as may be appropriate to carry out section 116 and this part, including regulations--

`(1) providing for the treatment of options and convertible debt as stock, including modification of the attribution rules under section 318(a)(4),

`(2) providing for the allocation of the excludable dividend amount and the cumulative retained earnings basis adjustment amount in the case of transactions described in section 312(h),

`(3) waiving the application of section 246(c)(4) for purposes of sections 286(b) and 1059(g),

`(4) modifying the consolidated return regulations to the extent necessary or appropriate to apply the provisions of this part, including regulations that accelerate the inclusion in the excludable dividend amount of a higher-tier member with respect to--

`(A) activities of lower-tier members of the group,

`(B) dividends excludable under section 116(a) received from such lower-tier members, and

`(C) increases in basis allocated under section 282 to stock in such lower-tier members,

`(5) providing for the application of section 116 and this part in the case of pass-thru entities, including appropriate adjustments to basis, and

`(6) as are necessary to further the purposes of section 116 and this part and to prevent the circumvention of such purposes.

Any regulations under paragraph (4) may be effective as of the effective date of this part.'

(b) REPORTING OF EXCLUDABLE DIVIDENDS AND RETAINED EARNINGS BASIS ADJUSTMENTS-

(1) IN GENERAL- Section 6042(a) (relating to returns regarding payments of dividends and corporate earnings and profits) is amended to read as follows:

`(a) REQUIREMENT OF REPORTING-

`(1) IN GENERAL- Every person--and this part and to prevent the circumvention of such purposes.

Any regulations under paragraph (4) may be effective as of the effective date of this part.'

(b) REPORTING OF EXCLUDABLE DIVIDENDS AND RETAINED EARNINGS BASIS ADJUSTMENTS-

(1) IN GENERAL- Section 6042(a) (relating to returns regarding payments of dividends and corporate earnings and profits) is amended to read as follows:

`(a) REQUIREMENT OF REPORTING-

`(1) IN GENERAL- Every person--

`(A) who makes payments of dividends aggregating $10 or more to any other person during any calendar year,

`(B) who allocates under section 282 increases in basis of stock in a corporation aggregating $10 or more to any other person during any calendar year,

`(C) who makes distributions described in section 283(a) aggregating $10 or more to any other person during any calendar year, or

`(D) who receives such payments of dividends, allocations of increases in basis, or distributions as a nominee and who makes payments or allocates increases aggregating $10 or more during any calendar year to any other person with respect to the dividends, allocations, or distributions received,

shall make a return at the time and in the manner prescribed by the Secretary, setting forth the information described in paragraph (3).

`(2) RETURNS REQUIRED BY SECRETARY- Every person who makes payments of dividends, allocations under section 282, or distributions described in section 283(a) to which paragraph (1) does not apply shall, when required by the Secretary, make a return setting forth the information described in paragraph (3).

`(3) INFORMATION REPORTED- Information described in this paragraph includes--

`(A) the aggregate amount of dividends, including the portion of such amount excludable from gross income under section 116(a),

`(B) the amount of each allocation of basis under section 282 with respect to each share of stock and the date of such increase,

`(C) the amount of each distribution described in section 283(a), including the portion of such amount to which paragraph (2) or (3) of section 301(c) applies and the date of such distribution, and

`(D) such other information as the Secretary may require.

In the case of a nominee described in paragraph (1)(D), this paragraph shall apply with respect to the payments and allocations made by the nominee.'

(2) APPLICATION TO FOREIGN PERSONS- Section 6042 is amended by adding at the end the following new subsection:

`(e) APPLICATION TO FOREIGN PERSONS- The Secretary may provide for the application of this section to payments, allocations, and distributions made by or to a foreign person to the extent necessary to carry out the provisions of section 116 and part X of subchapter B of chapter 1.'

(3) CONFORMING AMENDMENTS-

(A) Section 6042(b)(3) is amended by striking `or (B)' and inserting `or (D)'.

(B) Section 6042(c)(2) is amended to read as follows:

`(2) the information described in subsection (a)(3) required to be shown on the return.'

(c) AMENDMENTS TO OTHER SECTIONS-

(1) MINIMUM TAX- Clause (i) of section 56(g)(4)(B) is amended by striking `or under section 114' and inserting `, section 114, or section 116'.

(2) COORDINATION WITH DIVIDEND RECEIVED DEDUCTIONS-

(A) Section 246 is amended by adding at the end the following new subsection:

`(f) COORDINATION WITH DIVIDEND EXCLUSION- No deduction shall be allowed under section 243, 244, or 245 with respect to the amount of any dividend excluded from gross income under section 116 or would be so excluded but for sections 285(b)(1) and 286(d).'

(B) Section 243 is amended by adding at the end the following new subsection:

`(f) TERMINATION- Paragraph (1) of subsection (a) shall not apply to any dividend--

`(1) paid from earnings and profits accumulated in taxable years ending after April 1, 2001,

`(2) made with respect to stock issued after February 2, 2003, or

`(3) received by a corporation after December 31, 2005.'

(3) CARRYOVERS IN CERTAIN CORPORATION ACQUISITIONS- Section 381(c) is amended by adding at the end the following new paragraph:

`(27) EDA AND CREBAA- The acquiring corporation shall take into account (to the extent proper to carry out the purposes of this section, section 116, and part X of subchapter B, and under such regulation as may be prescribed by the Secretary) the excludable dividend amount and the cumulative retained earnings basis adjustment amount in respect of the distributor or transferor.'

(4) TRUSTS AND ESTATES- Subsection (a) of section 643 is amended--

(A) by redesignating paragraph (7) as paragraph (8) and by inserting after paragraph (6) the following new paragraph:

`(7) DIVIDENDS, ETC- There shall be included the amount of any dividends excluded from gross income under section 116 and the amount of any distribution described in section 283.', and

(B) by striking `and (6)' in the last sentence and inserting `, (6), and (7)'.

(5) PARTNERSHIPS-

(A) Paragraph (5) of section 702(a) is amended to read as follows:

`(5) dividends with respect to which there is an exclusion under section 116 or a deduction under part VIII of subchapter B,'.

(B) Section 705(a)(1) is amended by striking `and' at the end of subparagraph (B), by striking the semicolon at the end of subparagraph (C) and inserting `, and', and by adding at the end the following new subparagraph:

`(D) increases in basis under section 116(b) allocated to the partnership;'.

(6) EXTRAORDINARY DIVIDENDS-

(A) IN GENERAL- Section 1059 is amended by redesignating subsection (g) as subsection

(h) and by inserting after subsection (f) the following new subsection:

`(g) TREATMENT OF EXCLUDABLE DIVIDENDS AND RETAINED EARNINGS BASIS ADJUSTMENTS AS EXTRAORDINARY DIVIDENDS-

`(1) IN GENERAL- For purposes of this section, any dividend excludable under section 116(a) or increase in basis under section 116(b) shall be treated as an extraordinary dividend, except that this section shall be applied by substituting `1 year (or such other period as the Secretary may prescribe)' for `2 years' each place it appears.

`(2) TREATMENT OF DEEMED EXTRAORDINARY DIVIDENDS- The excludable dividend amount of any corporation for a calendar year, and its earnings and profits, shall not be increased by--

`(A) the dividends received by the corporation which are treated as extraordinary dividends by reason of paragraph (1), and

`(B) the aggregate increases in basis under section 116(b) which are so treated.

`(3) REGULATIONS- The Secretary may by regulation provide for exceptions to the application of paragraph (1).'

(B) Paragraph (3) of section 1059(d) is amended by inserting `section 1223(11) shall not apply and' after `subsection (a),'.

(C)(i) Section 1059 is amended by striking `corporation' each place it appears in subsection (a) and inserting `taxpayer'.

(ii) The section heading for section 1059 is amended by striking `corporate' and by inserting `and excludable' before `dividends'.

(iii) The item relating to section 1059 in the table of sections for part IV of subchapter O of chapter 1 is amended by striking `corporate' and by inserting `and excludable' before `dividends'.

(7) PRIVATE FOUNDATIONS- Section 4940(c) is amended by adding at the end the following new paragraph:

`(6) COORDINATION WITH DIVIDEND EXCLUSION- For purposes of this section, gross investment income shall not include--

`(A) a dividend to the extent excluded from gross income under section 116(a), and

`(B) a distribution described in section 283.'

(d) CONFORMING AMENDMENTS-

(1)(A) Part X of subchapter B of chapter 1, as in effect on the day before the date of the enactment of this Act, is hereby moved after part XI of such subchapter B and redesignated as part XII.

(B) Section 281, as so in effect, is redesignated as section 296.

(C) The table of sections for such part XII, as so designated, is amended by striking `Sec. 281' and inserting `Sec. 296.

(D) The table of parts for subchapter B of chapter 1 is amended by striking the items relating to parts X and XI and inserting the following new items:

`Part X. Rules for application of dividend exclusion and retained earnings basis adjustments.

`Part XI. Special rules relating to corporate preference items.

`Part XII. Terminal railroad corporations and their shareholders.'

(2) Subsection (f) of section 301 is amended by adding at the end the following new paragraph:

`(4) For exclusion from gross income of certain dividends, see section 116.'

SEC. 203. TREATMENT OF REGULATED INVESTMENT COMPANIES AND REAL ESTATE INVESTMENT TRUSTS.

(a) IN GENERAL- Section 852 is amended by adding at the end the following new subsection:

`(g) SPECIAL RULES RELATING TO SECTION 116 AND PART X OF SUBCHAPTER B-

`(1) EXCLUDABLE PORTION-

`(A) IN GENERAL- For purposes of section 116(a), the excludable portion of any dividend paid by any qualified investment entity shall be the amount so designated by such entity in a written notice mailed to its shareholders not later than 60 days after the close of its taxable year in which such dividend is paid.

`(B) LIMITATION- If the aggregate amount so designated with respect to a taxable year (including dividends paid after the close of the taxable year as described in section 855) exceeds the aggregate amount of dividends received by such entity during such year which are excludable from gross income under section 116(a), then the amount of a dividend otherwise excludable by reason of a designation under subparagraph (A) shall be reduced by an amount which bears the same ratio to the amount otherwise excludable as such excess bears to the total amount designated under subparagraph (A).

`(C) TREATMENT OF CAPITAL GAIN AND EXEMPT-INTEREST DIVIDENDS- Any amount designated under subparagraph (A) as excludable under section 116 may not be treated as a capital gain dividend or an exempt-interest dividend.

`(D) COORDINATION WITH SECTION 853- The election under section 853 shall not apply to dividends excludable under section 116 and distributions described in section 283(a) received by a qualified investment entity.

`(2) RETAINED EARNINGS BASIS ADJUSTMENTS-

`(A) IN GENERAL- A qualified investment entity may allocate any increase in basis allocated to the entity under section 282 to shares of stock in the entity at 1 or more times during the taxable year in the manner and the time prescribed in paragraphs (2) and (3) of section 282(b).

`(B) DESIGNATION- For purposes of section 116(b), the increase in basis allocated to any share of stock in the entity shall be the amount so designated by such entity in a written notice mailed to its shareholders not later

than 60 days after the close of its taxable year in which such allocation is made.

`(C) LIMITATION- Rules similar to the rules of paragraph (1)(B) shall apply to amounts allocated under this paragraph.

`(D) SHAREHOLDER TREATMENT OF AMOUNTS DESIGNATED- Shareholders of such entity who receive an allocation under this paragraph from such entity shall take into account such allocation as if it were an allocation under section 282.

`(E) EARNINGS AND PROFITS- Earnings and profits of the entity making such an allocation shall be adjusted in the same manner as provided in section 282(c).

`(3) CERTAIN DISTRIBUTIONS AFTER PREVIOUS RETAINED EARNINGS BASIS ADJUSTMENTS-

`(A) IN GENERAL- If any qualified investment entity receives during any taxable year distributions described in section 283(a) which reduced the basis of stock held by such entity under section 301(c)(2), the entity may designate any distributions described in section 301(a) made by such entity in such taxable year which are not excludable under section 116(a) (after the application of paragraph (1)) as distributions described in section 283(a). Such designations shall be made in a written notice mailed to its shareholders not later than 60 days after the close of its taxable year in which such distribution is made.

`(B) LIMITATION- If the aggregate amount so designated with respect to a taxable year (including distributions paid after the close of the taxable year as provided in section 855(e)) exceeds the aggregate distributions described in section 283(a) which reduced the basis of stock held by such entity under section 301(c)(2) for such taxable year, then the amount of a distribution otherwise treated as a distribution described in section 283(a) by reason of a designation under subparagraph (A) shall be reduced by an amount which bears the same ratio to the amount otherwise so treated as such excess bears to the total amount designated under subparagraph (A).

`(C) SHAREHOLDER TREATMENT OF AMOUNTS DESIGNATED- Shareholders of such entity who receive a distribution from such entity which is designated under this paragraph shall treat such distribution as a distribution described in section 283(a).

`(D) TREATMENT OF CAPITAL GAIN AND EXEMPT-INTEREST DIVIDENDS- Any distribution designated under subparagraph (A) may not be treated as a capital gain dividend or an exempt-interest dividend.

`(E) ADJUSTMENTS- No adjustment shall be made in the earnings and profits of a qualified investment entity with respect to a distribution by such entity which is designated under subparagraph (A).

`(4) COORDINATION WITH DIVIDENDS PAID DEDUCTION- No allocation or distribution designated under paragraph (2) or (3) shall be treated as a dividend for purposes of section 561.

`(5) DEFINITIONS- For purposes of this subsection--

`(A) QUALIFIED INVESTMENT ENTITY- The term `qualified investment entity' means--

`(i) a regulated investment company, and

`(ii) a real estate investment trust.

`(B) EXEMPT-INTEREST DIVIDEND- The term `exempt-interest dividend' has the meaning given to such term by subsection (b)(5).'

(b) OTHER RULES RELATING TO REGULATED INVESTMENT COMPANIES-

(1) DISTRIBUTION REQUIREMENTS-

(A) Clause (i) of section 852(a)(1)(B) is amended by inserting `and its dividend income excludable under section 116(a),' before `over'.

(B) Section 852(a) is amended by striking `and' at the end of paragraph (1), by redesignating paragraph (2) as paragraph (3), and by inserting after paragraph (1) the following new paragraph:

`(2) 90 percent of the distributions described in section 283(a)--

`(A) which are received by such company during the taxable year, and

`(B) which reduce under section 301(c)(2) the basis of stock held by such company,

are distributed during such year under subsection (g)(3)(A), and'.

(C) Section 855 is amended by adding at the end the following new subsection:

`(e) DISTRIBUTION OF PREVIOUSLY RETAINED EARNINGS BASIS ADJUSTMENTS- Rules similar to the rules of the preceding provisions of this section shall apply to distributions described in section 852(g)(3)(A).'

(2) TAXATION OF ENTITY AND SHAREHOLDERS-

(A) The material following paragraph (3) of section 851(b) is amended--

(i) by inserting `, dividends excludable from gross income under section 116(a), and distributions described in section 283(a) which reduce the basis of stock under section 301(c)(2)' after `103(a)' in the third sentence, and

(ii) by adding at the end the following new sentence: `For purposes of paragraph (2), distributions described in section 283(a) which reduce the basis of stock under section 301(c)(2) shall be treated as dividends.'

(B) Section 852(b)(2)(D) is amended by striking `and exempt-interest dividends' and inserting `, exempt-interest dividends, and any dividends excludable under section 116(a)'.

(C) Subparagraph (B) of section 852(b)(4) is amended to read as follows:

`(B) LOSS ATTRIBUTABLE TO EXEMPT DIVIDENDS- If--

`(i) a shareholder of a regulated investment company receives an exempt-interest dividend, a dividend excludable under section 116(a), or an allocation under subsection (g)(2), with respect to any share, and

`(ii) such share is held by the taxpayer for 6 months or less,

then any loss on the sale or exchange of such share shall, to the extent of the sum of the amounts of such dividends and allocations, be disallowed.'

(D) Paragraph (3) of section 4982(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 new subparagraph:

`(C) any dividend excludable from gross income under section 116(a).'

(c) OTHER RULES RELATING TO REAL ESTATE INVESTMENT TRUSTS-

(1) DISTRIBUTION REQUIREMENTS-

(A) Subparagraph (A) of section 857(a)(1) is amended by striking `and' at the end of clause (i), by striking `minus' at the end of clause (ii), and by inserting at the end the following new clause:

`(iii) 90 percent of its dividend income excludable under section 116(a); minus'

(B) Subsection (a) of section 857 is amended by redesignating paragraph (2) as paragraph (3) and by inserting after paragraph (1) the following new paragraph:

`(2) 90 percent of the distributions described in section 283(a)--

`(A) which are received by such trust during the taxable year, and

`(B) which reduce under section 301(c)(2) the basis of stock held by such trust,

are distributed during such year under subsection (g)(3)(A); and'.

(C) Section 858 is amended by adding at the end the following new subsection:

`(d) DISTRIBUTION OF PREVIOUSLY RETAINED EARNINGS BASIS ADJUSTMENTS- Rules similar to the rules of the preceding provisions of this section shall apply to distributions described in section 852(g)(3).'

(2) TAXATION OF ENTITY AND SHAREHOLDERS-

(A)(i) Section 856(c)(2) is amended--

(I) by inserting `(including dividends excludable from gross income under section 116(a)) and distributions described in section 283(a) which reduce the basis of stock under section 301(c)(2)' after `dividends' in subparagraph (A), and

(II) by inserting `(including tax-exempt interest)' after `interest' in subparagraph (B).

(ii) Section 856(c) is amended by adding at the end the following new paragraph:

`(8) GROSS INCOME TESTS- For purposes of paragraphs (2) and (3), gross income shall be treated as including tax-exempt interest, dividends excludable from gross income under section 116(a), and distributions described in section 283(a) which reduce the basis of stock under section 301(c)(2).'

(B) Section 857(b)(2)(B) is amended by inserting `or any dividends paid which are excludable under section 116(a)' after `subparagraph (D)'.

(C) Section 857(b) is amended by adding at the end the following new paragraph:

`(10) LOSS ATTRIBUTABLE TO EXEMPT DIVIDENDS- If--

`(A) a shareholder of a real estate investment trust receives a dividend excludable under section 116(a) or an allocation under section 852(g)(2) with respect to any share, and

`(B) such share is held by the taxpayer for 6 months or less,

then any loss on the sale or exchange of such share shall, to the extent of the sum of the amounts of such dividends and allocations, be disallowed.'

(D) Subsection (g) of section 857 is amended to read as follows:

`(g) CROSS REFERENCES-

`(1) For provisions relating to excise tax based on certain real estate investment trust taxable income not distributed during the taxable year, see section 4981.

`(2) For special rules relating to application of dividend exclusion and retained earnings basis adjustments, see section 852(g).'

(E) Paragraph (1) of section 4981(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 new subparagraph:

`(C) any dividend excludable from gross income under section 116(a).'

SEC. 204. TREATMENT OF INSURANCE COMPANIES.

(a) LIFE INSURANCE COMPANIES-

(1) Section 803 is amended by adding at the end the following new subsection:

`(c) SPECIAL RULES FOR EXCLUDABLE DIVIDENDS AND RETAINED EARNINGS BASIS ADJUSTMENTS-

`(1) IN GENERAL- The exclusion under section 116(a) with respect to any dividend received by a life insurance company shall only apply to such company's share (as determined under section 812) of such dividend.

`(2) RETAINED EARNINGS BASIS ADJUSTMENTS- In the case of any increase in basis under

section 116(b) allocated under section 282 to stock held by a life insurance company--

`(A) the life insurance company's and policyholders' shares of such allocation shall be determined in accordance with section 812 in the same manner as if it were a dividend, and

`(B) life insurance company gross income of such company shall be increased by the policyholders' share of such allocation.

`(3) RULES FOR SEGREGATED ASSET ACCOUNTS- In the case of stock held in a segregated asset account (within the meaning of section 817), this subsection shall be applied as if the policyholders' share of the excludable portion of any dividend, or any increase in basis under section 116(b), with respect to such stock were 100 percent.

`(4) COMPUTATION OF EXCLUDABLE DIVIDEND AMOUNT- In the case of a life insurance company, the increase under clause (ii) or (iii) of section 281(b)(1)(A) in the company's excludable dividend amount shall be limited to the company's share (as determined under section 812) of the dividends or increases in basis described in either such clause.'

(2) Section 812(d)(1)(A) is amended by inserting `(including dividends excludable under section 116(a))' after `dividends'.

(3) Section 815(c)(2)(A)(iii) is amended by adding `, the amount of dividends excludable under section 116(a) (as modified by section 803(c)(1)), and the amount of basis increase under section 116(b) (as modified by section 803(c)(2))' after `section 103'.

(b) OTHER INSURANCE COMPANIES-

(1) Section 832(b)(5)(B) is amended by striking `and' at the end of clause (ii), by striking the period at the end of clause (iii) and inserting `, and', and by adding after clause (iii) the following new clause:

`(iv) any dividend excludable under section 116(a) which is received during such taxable year and any increase in basis under section 116(b) which is allocated under section 282 to such company during such taxable year.'

(2) Section 832(c) is amended by striking `and' at the end of paragraph (12), by striking the period at the end of paragraph (13) and inserting `; and', and by adding at the end the following new paragraph:

`(14) the amount of dividends received during the taxable year which are excluded from gross income under section 116(a).'

(3) Section 833(b)(3)(E) is amended--

(A) by striking `and' at the end of clause (i), by striking the period at the end of clause (ii) and inserting `, and', and by inserting after clause (ii) the following new clause:

`(iii) the aggregate amount excluded for the taxable year under section 116(a).', and

(B) by adding at the end the following: `The amount determined under clause (iii) shall be reduced by the amount of any decrease in such deductions for the taxable year by reason of section 832(b)(5)(B) to the extent such decrease is attributable to the exclusion under section 116(a).'

(4) Section 834(c) is amended by adding at the end the following new paragraph:

`(10) EXCLUDABLE DIVIDENDS- The amount of dividends received during the taxable year which are excluded from gross income under section 116(a).'

SEC. 205. TREATMENT OF S CORPORATIONS.

(a) BASIS ADJUSTMENTS RELATING TO DIVIDENDS- Section 1367(a)(1) is amended by striking `and' at the end of subparagraph (B), by striking the period at the end of subparagraph (C) and inserting `, and', and by adding at the end the following new subparagraph:

`(D) increases in basis under section 116(b) allocated to the S corporation.'.

(b) Application of Section 116 and Part X of Subchapter B to S Corporations-

(1) IN GENERAL- Section 1368 is amended by adding at the end the following new subsection:

`(f) COORDINATION WITH DIVIDEND EXCLUSION AND RETAINED EARNINGS BASIS ADJUSTMENTS-

`(1) DETERMINATION OF EXCLUDED DIVIDENDS AMOUNT-

`(A) IN GENERAL- Clauses (ii) and (iii) of section 281(b)(1)(A) shall not apply to amounts received or allocated in a taxable year for which the corporation is an S corporation.

`(B) CROSS REFERENCE-

`(2) DISTRIBUTIONS- Subject to regulations prescribed by the Secretary, the preceding provisions of this section shall not apply to any dividend excludable from gross income under section 116(a) and any distribution described in section 283(a).'

(c) Modification to Treatment of Section 1374 Tax-

(1) Paragraph (2) of section 1366(f) is amended to read as follows:

`(2) TREATMENT OF TAX IMPOSED ON BUILT-IN GAINS- The amount of the items of the net recognized built-in-gain taken into account under section 1374(b)(1) (reduced by any deduction allowed under section 1374(b)(2)) shall not be taken into account under this section.'

(2)(A) Subsection (c) of section 1371 is amended by adding at the end the following new paragraph:

`(B) EARNINGS AND PROFITS- The accumulated earnings and profits of the corporation shall be increased at the beginning of the taxable year by the amount not taken into account under section 1366 by reason of section

1366(f)(2) (determined without regard any reduction of such amount under section 1374(b)(2)) reduced by the tax imposed by section 1374 (net of credits allowed).'

(B) Paragraph (1) of section 1371(c) is amended by striking `and (3)' and inserting `, (3), and (4)'.

(d) REPEAL OF TAX AND TERMINATION WHERE EXCESS PASSIVE INVESTMENT INCOME-

(1) REPEAL OF TAX-

(A) IN GENERAL- Section 1375 is repealed.

(B) CONFORMING AMENDMENTS- Sections 26(b)(2)(J) and 1366(f)(3) are repealed.

(2) REPEAL OF TERMINATION- Section 1362(d) is amended by striking paragraph (3).

SEC. 206. REPEAL OF ACCUMULATED EARNINGS TAX AND PERSONAL HOLDING COMPANY TAX.

(a) IN GENERAL- Parts I and II of subchapter G of chapter 1 (relating to corporations improperly accumulating surplus and to personal holding companies) are hereby repealed.

(b) CONFORMING AMENDMENTS-

(1) Section 12 is amended by striking paragraph (2) and by redesignating paragraphs (3), (4), (5), (6), and (7) as paragraphs (2), (3), (4), (5), and (6), respectively.

(2) Section 26(b)(2) is amended by striking subparagraphs (F) and (G).

(3) Section 30A(c) is amended by inserting `or' at the end of paragraph (1), by striking paragraphs (2) and (3), and by redesignating paragraph (4) as paragraph (2).

(4) Section 41(e)(7)(E) is amended by adding `and' at the end of clause (i), by striking clause (ii), and by redesignating clause (iii) as clause (ii).

(5) Section 56(b)(2) is amended by striking subparagraph (C) and by redesignating subparagraph (D) as subparagraph (C).

(6) Section 111 is amended by striking subsection (d).

(7) Section 170(e)(4)(D) is amended by adding `and' at the end of clause (i), by striking clause (ii), and by redesignating clause (iii) as clause (ii).

(8) Sections 170(f)(10)(A), 508(d), 4947, and 4948(c)(4) are each amended by striking `545(b)(2),' each place it appears.

(9)(A) Section 316(b) is amended by striking paragraph (2) and by redesignating paragraph (3) as paragraph (2).

(B) Section 331(b) is amended by striking `(other than a distribution referred to in paragraph (2)(B) of section 316(b))'.

(10) Section 341(d) is amended--

(A) by striking `section 544(a) (relating to personal holding companies)' and inserting `section 465(f) (relating to constructive ownership rules)', and

(B) by inserting before the period at the end of the next to the last sentence `and such paragraph (2) shall be applied by inserting `or by or for his partner' after `his family'.

(11) Section 381(c) is amended by striking paragraphs (14) and (17).

(12) Section 443(e) is amended by striking paragraphs (1) and (2) and by redesignating paragraphs (3), (4), and (5) as paragraphs (1), (2), and (3), respectively.

(13) Section 447(g)(4)(A) is amended by striking `other than--' and all that follows and inserting `other than an S corporation.'

(14)(A) Section 465(a)(1)(B) is amended to read as follows:

`(B) a C corporation which is closely held,'.

(B) Section 465(a)(3) is amended to read as follows:

`(3) CLOSELY HELD DETERMINATION- For purposes of paragraph (1), a corporation is closely held if, at any time during the last half of the taxable year, more than 50 percent in value of its outstanding stock is owned, directly or indirectly, by or for not more than 5 individuals. For purposes of this paragraph, an organization described in section 401(a), 501(c)(17), or 509(a) or a portion of a trust permanently set aside or to be used exclusively for the purposes described in section 642(c) shall be considered an individual.'

(C) Section 465(c)(7)(B) is amended by striking clause (i) and by redesignating clauses (ii) and (iii) as clauses (i) and (ii), respectively.

(D) Section 465(c)(7)(G) is amended to read as follows:

`(G) LOSS OF 1 MEMBER OF AFFILIATED GROUP MAY NOT OFFSET INCOME OF PERSONAL SERVICE CORPORATION- Nothing in this paragraph shall permit any loss of a member of an affiliated group to be used as an offset against the income of any other member of such group which is a personal service corporation (as defined in section 269A(b) but determined by substituting `5 percent' for `10 percent' in section 269A(b)(2)).'

(E) Section 465 is amended by adding at the end the following new subsection:

`(f) CONSTRUCTIVE OWNERSHIP RULES- For purposes of subsection (a)(3)--

`(1) STOCK NOT OWNED BY INDIVIDUAL- Stock owned, directly or indirectly, by or for a corporation, partnership, estate, or trust shall be considered as being owned proportionately by its shareholders, partners, or beneficiaries.

`(2) FAMILY OWNERSHIP- An individual shall be considered as owning the stock owned, directly or indirectly, by or for his family. For purposes of this paragraph, the family of an individual includes only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants.

`(3) OPTIONS- If any person has an option to acquire stock, such stock shall be considered as owned by such person. For purposes of this paragraph, an option to acquire such an option, and each one of a series of such options, shall be considered as an option to acquire such stock.

`(4) APPLICATION OF FAMILY AND OPTION RULES- Paragraphs (2) and (3) shall be applied if, but only if, the effect is to make the corporation closely held under subsection (a)(3).

`(5) CONSTRUCTIVE OWNERSHIP AS ACTUAL OWNERSHIP- Stock constructively owned by a person by reason of the application of paragraph (1) or (3), shall, for purposes of applying paragraph (1) or (2), be treated as actually owned by such person; but stock constructively owned by an individual by reason of the application of paragraph (2) shall not be treated as owned by him for purposes of again applying such paragraph in order to make another the constructive owner of such stock.

`(6) OPTION RULE IN LIEU OF FAMILY RULE- If stock may be considered as owned by an individual under either paragraph (2) or (3) it shall be considered as owned by him under paragraph (3).

`(7) CONVERTIBLE SECURITIES- Outstanding securities convertible into stock (whether or not convertible during the taxable year) shall be considered as outstanding stock if the effect of the inclusion of all such securities is to make the corporation closely held under subsection (a)(3). The requirement under the preceding sentence that all convertible securities must be included if any are to be included shall be subject to the exception that, where some of the outstanding securities are convertible only after a later date than in the case of others, the class having the earlier conversion date may be included although the others are not included, but no convertible securities shall be included unless all outstanding securities having a prior conversion date are also included.'

(15)(A) Section 553(a)(1) is amended by striking `section 543(d)' and inserting `subsection (c)'.

(B) Section 553 is amended by adding at the end the following new subsection:

`(c) ACTIVE BUSINESS COMPUTER SOFTWARE ROYALTIES-

`(1) IN GENERAL- For purposes of subsection (a), the term `active business computer software royalties' means any royalties--

`(A) received by any corporation during the taxable year in connection with the licensing of computer software, and

`(B) with respect to which the requirements of paragraphs (2), (3), and (4) are met.

`(2) ROYALTIES MUST BE RECEIVED BY CORPORATION ACTIVELY ENGAGED IN COMPUTER SOFTWARE BUSINESS- The requirements of this paragraph are met if the royalties described in paragraph (1)--

`(A) are received by a corporation engaged in the active conduct of the trade or business of developing, manufacturing, or producing computer software, and

`(B) are attributable to computer software which--

`(i) is developed, manufactured, or produced by such corporation (or its predecessor) in connection with the trade or business described in subparagraph (A), or

`(ii) is directly related to such trade or business.

`(3) ROYALTIES MUST CONSTITUTE AT LEAST 50 PERCENT OF INCOME- The requirements of this paragraph are met if the royalties described in paragraph (1) constitute at least 50 percent of the ordinary gross income of the corporation for the taxable year.

`(4) DEDUCTIONS UNDER SECTIONS 162 AND 174 RELATING TO ROYALTIES MUST EQUAL OR EXCEED 25 PERCENT OF ORDINARY GROSS INCOME-

`(A) IN GENERAL- The requirements of this paragraph are met if--

`(i) the sum of the deductions allowable to the corporation under sections 162, 174, and 195 for the taxable year which are properly allocable to the trade or business described in paragraph (2) equals or exceeds 25 percent of the ordinary gross income of such corporation for such taxable year, or

`(ii) the average of such deductions for the 5-taxable year period ending with such taxable year equals or exceeds 25 percent of the average ordinary gross income of such corporation for such period.

If a corporation has not been in existence during the 5-taxable year period described in clause (ii), then the period of existence of such corporation shall be substituted for such 5-taxable year period.

`(B) DEDUCTIONS ALLOWABLE UNDER SECTION 162- For purposes of subparagraph (A), a deduction shall not be treated as allowable under section 162 if it is specifically allowable under another section.

`(C) LIMITATION ON ALLOWABLE DEDUCTIONS- For purposes of subparagraph (A), no

deduction shall be taken into account with respect to compensation for personal services rendered by the 5 individual shareholders holding the largest percentage (by value) of the outstanding stock of the corporation. For purposes of the preceding sentence individuals holding less than 5 percent (by value) of the stock of such corporation shall not be taken into account.'

(16) Section 556(b)(1) is amended by striking `, but not including' and all that follows and inserting a period.

(17) Section 561(a) is amended by striking paragraph (3), by inserting `and' at the end of paragraph (1), and by striking `, and' at the end of paragraph (2) and inserting a period.

(18) Section 562(b) is amended to read as follows:

`(b) DISTRIBUTIONS IN LIQUIDATION- Except in the case of a foreign personal holding company described in section 552--

`(1) in the case of amounts distributed in liquidation, the part of such distribution which is properly chargeable to earnings and profits accumulated after February 28, 1913, shall be treated as a dividend for purposes of computing the dividends paid deduction, and

`(2) in the case of a complete liquidation occurring within 24 months after the adoption of a plan of liquidation, any distribution within such period pursuant to such plan shall, to the extent of the earnings and profits (computed without regard to capital losses) of the corporation for the taxable year in which such distribution is made, be treated as a dividend for purposes of computing the dividends paid deduction.

For purposes of paragraph (1), a liquidation includes a redemption of stock to which section 302 applies. Except to the extent provided in regulations, the preceding sentence shall not apply in the case of any mere holding or investment company which is not a regulated investment company.'

(19) Section 563 is amended by striking subsections (a) and (b), by redesignating subsections (c) and (d) as subsections (a) and (b), and by striking `, (b), or (c)' in subsection (b) (as so redesignated).

(20) Section 564 is hereby repealed.

(21) Section 631(c) is amended by striking the next to the last sentence and inserting the following: `This subsection shall have no application for purposes of applying subchapter G (relating to corporations used to avoid income tax on shareholders).'.

(22) Section 852(b)(1) is amended by striking `which is a personal holding company (as defined in section 542) or'.

(23)(A) Section 856(h)(1) is amended to read as follows:

`(1) IN GENERAL- For purposes of subsection (a)(6), a corporation, trust, or association is closely held if the stock ownership requirement of section 465(a)(3) is met.'.

(B) Section 856(h)(3)(A)(i) is amended by striking `section 542(a)(2)' and inserting `section 465(a)(3)'.

(C) Paragraph (3) of section 856(h) is amended by striking subparagraph (B) and by redesignating subparagraphs (C) and (D) as subparagraphs (B) and (C), respectively.

(D) Subparagraph (C) of section 856(h)(3), as redesignated by the preceding subparagraph, is amended by striking `subparagraph (C)' and inserting `subparagraph (B)'.

(24) The last sentence of section 882(c)(2) is amended to read as follows:

`The preceding sentence shall not be construed to deny the credit provided by section 33 for tax withheld at source or the credit provided by section 34 for certain uses of gasoline.'.

(25) Section 936(a)(3) is amended by striking subparagraphs (B) and (C), by inserting `or' at the end of subparagraph (A), and by redesignating subparagraph (D) as subparagraph (B).

(26) Section 936 is amended by striking subsection (g).

(27) Section 992(d) is amended by striking paragraph (2) and by redesignating paragraphs (3), (4), (5), (6), and (7) as paragraphs (2), (3), (4), (5), and (6), respectively.

(28) Section 992 is amended by striking subsection (e).

(29) Section 1202(e)(8) is amended by striking `section 543(d)(1)' and inserting `section 553(c)(1)'.

(30) Section 1298(b) is amended by striking paragraph (8) and redesignating paragraph (9) as paragraph (8).

(31) Section 1504(c)(2)(B) is amended by adding `and' at the end of clause (i), by striking clause (ii), and by redesignating clause (iii) as clause (ii).

(32)(A) Section 1551(a) is amended by striking `or the accumulated earnings credit' and all that follows and inserting `unless such transferee corporation shall establish by the clear preponderance of the evidence that the securing of such benefits was not a major purpose of such transfer.'.

(B) The section heading for section 1551 is amended by striking `and accumulated earnings credit'.

(C) The item relating to section 1551 in the table of sections for part I of subchapter B of chapter 6 is amended by striking `and accumulated earnings credit'.

(33)(A) Section 1561(a) is amended--

(i) by striking paragraph (2),

(ii) by redesignating paragraphs (3) and (4) as paragraphs (2) and (3),

(iii) by striking `paragraph (3)' each place it appears and inserting `paragraph (2)',

(iv) by striking `paragraph (4)' and inserting `paragraph (3)', and

(v) by striking the third sentence.

(B) Section 1561(b) is amended to read as follows:

`(b) CERTAIN SHORT TAXABLE YEARS- If a corporation has a short taxable year which does not include a December 31 and is a component member of a controlled group of corporations with respect to such taxable year, then for purposes of this subtitle, the amount in each taxable income bracket in the tax table in section 11(b) for such corporation for such taxable year shall be the amount specified in subsection (a)(1), divided by the number of corporations which are component members of such group on the last day of such taxable year. For purposes of the preceding sentence, section 1563(b) shall be applied as if such last day were substituted for December 31.'.

(34) Section 2057(e)(2)(C) is amended by adding at the end the following new sentence: `References to sections 542 and 543 in the preceding sentence shall be treated as references to such sections as in effect on the day before their repeal.'

(35) Sections 6422 is amended by striking paragraph (3) and by redesignating paragraphs (4) through (12) and paragraphs (3) through (11), respectively.

(36) Section 6501 is amended by striking subsection (f).

(37) Section 6503(k) of such Code is amended by striking paragraph (1) and by redesignating paragraphs (2) through (5) as paragraphs (1) through (4), respectively.

(38) Section 6515 is amended by striking paragraph (1) and by redesignating paragraphs (2) through (6) as paragraphs (1) through (5), respectively.

(39) Section 6601(b) is amended by striking paragraph (4) and redesignating paragraph (5) as paragraph (4).

(40) Subsections (d)(1)(B) and (e)(2) of section 6662 of such Code are each amended by striking `or a personal holding company (as defined in section 542)'.

(41) Section 6683 is hereby repealed.

(42) Section 7518(c)(1) is amended by inserting `and' at the end of subparagraph (C), by striking `, and' at the end of subparagraph (D) and inserting a period, and by striking subparagraph (E).

(c) CLERICAL AMENDMENTS-

(1) The table of parts for subchapter G of chapter 1 of such Code is amended by striking the items relating to parts I and II.

(2) The table of sections for part IV of such subchapter G is amended by striking the item relating to section 564.

(3) The table of sections for part I of subchapter B of chapter 68 of such Code is amended by striking the item relating to section 6683.

SEC. 207. EFFECTIVE DATES.

(a) IN GENERAL- Except as otherwise provided in this section, the amendments made by this title shall apply to distributions received, and basis allocations made under section 282 of the Internal Revenue Code of 1986 (as added by this title), after December 31, 2002.

(b) SPECIAL RULES-

(1) SECTION 1374 TAX- In applying the amendments made by this title, any tax imposed by section 1374 of the Internal Revenue Code of 1986 for any taxable year beginning before January 1, 2003, shall not be taken into account.

(2) SECTIONS 205(d) AND 206- The amendments made by sections 205(d) and 206 shall apply to taxable years beginning after December 31, 2002; except that--

(A) section 547 of such Code (as in effect before its repeal) shall continue to apply to deficiency dividends (as defined in section 547(d) of such Code) relating to taxable years beginning before January 1, 2003, and

(B) subsections (a) and (b) of section 563 of such Code (as so in effect) shall continue to apply to dividends relating to taxable years beginning before January 1, 2003.

Notwithstanding subparagraphs (A) and (B), such dividends shall not be taken into account in applying section 116 of such Code or part X of subchapter B of chapter 1 of such Code.

END