Tax revision issues, 1976 (H.R. 10612)

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Title:
Tax revision issues, 1976 (H.R. 10612)
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United States -- Congress. -- Joint Committee on Internal Revenue Taxation
United States -- Congress. -- Senate. -- Committee on Finance
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U.S. Govt. Print. Off. ( Washington )
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Table of Contents
    Front Cover
        Page i
        Page ii
    Table of Contents
        Page iii
        Page iv
    1. Business use of homes
        Page 1
        Page 2
    2. Vacation homes
        Page 3
        Page 4
    3. Foreign convention expenses
        Page 5
        Page 6
        Page 7
    4. Qualified stock options
        Page 8
        Page 9
    5. Treatment of losses from nonbusiness guarantees
        Page 10
        Page 11
    6. Away from home expenses of state and congressional legislators
        Page 12
        Page 13
        Page 14
    Back Cover
        Page 15
        Page 16
Full Text
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COMMITTEEE PRINT]


TAX REVISION ISSUES-1976
(H.R. 10612)




4



BUSINESS RELATED INDIVIDUAL INCOME


TAX REVISIONS





PREPARED FOR THE USE OF TIIE

COMMITTEE ON FINANCE

BY THE STAFF OF TIHE

JOINT COMMITTEE ON INTERNAL REVENUE
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APRIL 14, 197t;





U.S. GOVERNMENT PRINTING OFFICE
59G6 WASHINGTON : 1976 JCS-11


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CONTENTS

Page
Introduction------------------------------------------------ 1
1. Business use of homes -------------------------------------------- 1
2. Vacation homes------------------------------------------------- 3
3. Foreign convention expenses ------------------------------------- 5
4. Qualified stock options------------------------------------------- 8
5. Treatment of losses from nonbusiness guarantees -------------------- 10
6. Away from home expenses of State and congressional legislators -------- 12
(in)



















































































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INTRODUCTION
This pamphlet presents background information regarding a series
of matters contained in the House-pas-.ed bill (H.R. 10612) relating to
the income tax deduction of bu.-iness or investment related expenses of
individuals. This pamphlet discusses in each case the present law treat-
ment, the issues which have been raised and how these matters are
dealt with in the House-passed bill. Subsequent pamphlets will dis-
cu.ss alternative proposals for dealing with these problems.
The matters discussed in this pamphlet include the tax treatment of
expenses related to the business use of homes, vacation homes and
foreign conventions, the tax treatment of qualified stock options, the
treatment of losses from nonbusiness guarantees, and the away from
home expenses of state and congressional legislators.

1. Business Use of Home
Present law
Under present law, deductions are allowed for personal, living, and
family expenses only to theextent expressly allowed under the code.
Generally, expenses and losses attributable to a dwelling which is oc-
cupied by a taxpayer as his personal residence are not deductible.
However, deductions for interest, certain taxes, and casualty losses
attributable to a personal residence are allowed under other provisions
of the tax laws. In addition, if a portion of the residence is used in the
taxpayer's trade or business or is used in the production of income, a
deduction may be allowed for a portion of the expenses incurred in
maintaining the resid(lence.
In any case involving the business use of a personal residence, it
must be established that the expenses were incurred in carrying on a
trade or business or for the production of income. Under the regula-
tions, the expense; of maintaining a household are treated as non-
deductible if the taxpayer only incidentally conducts business in his
home. However, if a part of the house is used as the taxpayer's place of
business, the allocable portion of the expen.-es attributable to the use of
the home as a place of business is allowed as a deduction.
For this purpose the expenses attributable to the business use of
the home arc deductible if they are "ordinary and necessary" expenses
paid or incurred in carrying on a trade or business or for the production
of income. Deductions are allowed self-employed individuals who use
portions of their residences for trade or business purposes.,, employees
who maintain offices in connection with the performance of their ditties
as employees, or investors who maintain offices in connection with
investment activities. Typically, the expen-es for which a deduction
is claimed include a portion of the depreciation or rent, maintenance,
utility, and insurance expenses incurred in connection with the
residence.
The position of the Internal Revenue Service is that the mainte-
nance of the office in the home must be required by the employer as a
(1)








condition of employment and regularly used for the performance of
the employee's duties. Certain courts have decided that a more liberal
standard is appropriate. Under these decisions, the expenses attribut-
able to an office maintained in an employee's residence are deductible
if the maintenance of the office is "appropriate and helpful" to the em-
ployee's business: George H. Newi, T.C. Memo. 1969-131, aff'd 432
F. 2d 998 (2d Cir. 1970); Jay R. Gill, T.C. Memo. 1975-3; Hall v.
United States, 387 F. Supp. 612 (D.C.N.H., 1975).
In Stephen A. Bodzin, 60 T.C. 820 (1973), the Tax Court, in allowing
a deduction for an office in an employee's residence, held that "the
applicable test for judging the deductibility of home office expenses is
whether, like any other business expense, the maintenance of an
office in the home is appropriate and helpful under all the circum-
stances." However, the court cautioned that no deduction would be
allowable if personal convenience were the primary reason for main-
taining the office notwithstanding any conclusion as to the "appro-
priateness" and "helpfulness" of the office. On appeal, the Fourth
Circuit reversed the decision of the Tax Court (509 F. 2d 679). The
Appellate Court held that, as a factual matter, the expenses attrib-
utable to the taxpayer's residence were nondeductible personal ex-
penses and that it was therefore unnecessary to decide if the mainte-
nance of the office was appropriate and helpful in carrying on his
business. The court suggested that to obtain a deduction, an employee
would have to show that the office provided by the employer is not
available at the times the employee uses the office in his residence or
that the employer's office is not suitable for the purposes for which the
taxpayer is using the office in his residence.1
In determining the deductible amount attributable to the business
use of the home, the general rule is that any reasonable method of allo-
cation may be used. In all cases involving the dual use of a home, the
allocation of expenses attributable to the portion of the residence used
for business purposes is to take into account the space used for those
purposes, e.g., a percentage of the expenses based on the square feet of
that portion compared to the total square feet of the residence. In addi-
tion, a further allocation based on time of use is required. The Internal
Revenue Service has ruled that this allocation should be made on the
basis of availability for use rather than actual use. However, the Tax
Coirt has held that such expenses should be allocated on the basis of
actual business use as compared with actual total use.
In another case where the allocation between business use and per-
sonal use could not clearly be determined, the allocation was made
on the basis of the approximate space of an apartment which was used
for business purposes.
Issue
Some favor a definitive rule to resolve the conflict that exists
between several recent court decisions and the position of the Internal
Revenue Service to determine the deductibility of expenses attribut-
able to the maintenance of an office in the taxpayer's personal
residence.
It is pointed out that under the "appropriate and helpful" standard
employed in the court decisions the determination of the allowance of
I The Supreme Court denied certiorari in the Bodzin case on October 6, 1975
(44 U.S.L.W. 3201).








a deduction for these expenses is necessarily a subjective determina-
tion. In the absence of definitive controlling standards, it is stated that
the "appropriate and helpful" test increases the inherent administra-
tive problems because both business and personal uses of the residence
are involved. It is also argued that in many cases the application of the
appropriate and helpful test results in treating personal, living, and
family expenses directly attributable to the home (and therefore not
deductible) as ordinary and necessary business expenses, even though
those expenses did not result in additional or incremental costs incurred
as a result of the business u-e of the home. Thus, it is contended that
expenses otherwise considered nondeductible personal, living, and
family expenses are converted into deductible business expenses
simply because, under the facts of the particular case, it was appro-
priate and helpful to perform some portion of the taxpayer's business
in his personal residence even though only minor incremental expenses
were incurred in order to perform these activities.
The House bill
Under the House bill, the taxpayer would not be permitted to
deduct any expenses attributable to the u-e of his home for business
purposes except as provided below.
Deductions for expenses attributable to the iiu- of a portion of the
taxpayer's residence for business use would be permitted with respect
to the portion of the home used exclusively on a reguLlar basis as:
(1) the taxpayer's principal place of business, or
(2) a place of business which is uezed for patients, clients, or
customers in meeting or dealing with the taxpayer in the normal
course of business.
However, under these two exceptions, deductions could not exceed
the income generated by the business activity of the taxpayer in
his home. Deductions would be permitted for certain inventory
storage. In addition, in the case of an employee, the businc<-, use
must be for the convenience of his. employer.
This provision would apply to taxable years beginning after De-
cemnber 31, 1975.
2. Vacation Homes
Prese nt law
Under present law, in order to be entitled to a deduction for business
or investment expenses, it is nece-sary that the activity in which
such expenses are incurred be engaged in by the taxpayer for profit
(i.e., for the purpose of or with the intention of making a profit).'
The determination of whether an activity is engaged in for profit is
made on the basis of objective standards, taking into account all
facts and circumstances of each case. Although a reasonable ex-
pectation of profit is not required, the facts and circumstances (without
regard to the taxpayer's subjective intent) must indicate that the
taxpayer entered the activity or continued the activity with the
objective of making a profit. However, a deduction is allowed for
interest, State and local property taxes, and (casualty losses without
regard to whether they are incurred in connection with a trade or
business or for the production of income






In addition, in the case of an activity not engaged in for profit, a
deduction is allowed for expenses which could be deducted if the
activity were engaged in for profit, but only to the extent these
expenses do not exceed the amount of gross income derived from the
activity reduced by the deductions which are allowed in any event
(e.g., interest and certain State and local taxes). In other words, as to
expenses such as depreciationinsurance, and maintenance, a taxpayer
is allowed a deduction but only to the extent of income derived from
the activity.
A taxpayer is presumed to be engaged in an activity for profit if,
in two or more years out of the last five years (seven years in the case
of the breeding, training, showing, or raising of horses) the activity
was carried on at a profit. For this purpose an activity is treated as
being carried on for a profit in a year if the gross income from the
activity exceeds the deductions attributable to it.
The Regulations provide a list of factors to be taken into account in
determining whether the activity is engaged in for profit. Among other
factors, the presence of personal motives must be considered, especially
where there are recreational or personal elements involved.2 By way of
illustration, the regulations provide that a taxpayer will be treated as
holding a beach house primarily for personal purposes if, during a
three-month season, the beach house is personally used by the taxpayer
for one month and used for the production of rents for the remaining
two months. However, except for this example, there are no definitive
rules' relating to how much personal use of vacation property will
result in a finding that the rental activities of vacation homes are
not engaged in for profit.
Issue
Where expenses attributable to a residence are treated as deductible
business expenses, it has been argued that an opportunity exists to con-
vert nondeductible personal, living and family expenses into deductible
expenses. In the case of so-called "vacation homes" that are used both
for personal purposes and for rental purposes, many feel that fre-
quently personal motives predominate and the rental activities are
undertaken to minimize the expenses of ownership of the property
rather than to make an economic profit.
It has been pointed out that in selling vacation homes, it is common
practice to emphasize that tax benefits can be obtained by renting the
property during part of the year, while reserving the remaining portion
for personal use. In addition, arrangements have been devised whereby
an individual owner of a condominium unit is entitled to exchange
the time set aside for the personal use of his own unit (typically three
to six weeks) for the use of a different unit under the same general
management.
Under many of these arrangements, it is suggested that it is ex-
trenmely difficult under existing law to determine when an activity is
engaged in for profit. It is noted that the present regulations provide
that, in making this determination, a number of factors shall be taken
into account. These factors include the presence of "personal motives,"
especially where there are recreational or personal elements involved.
1 See Morton v. Comnmissioncr, 174 F. 2d 302, 304 (2d Cir.), cert. denied, 338
U.S. 82S (1949); Schley v. Commissioner, 375 F. 2d 747 (2d Cir. 1967); and George
W. Mitchell, 47 T.C. 120 (1966).








However, except for the example mentioned above, no objective stand-
ards are set forth in the regulations. As a result, many believe that
definitive rules need to be provided to specify the extent to which per-
sonal use would result in the (disallowance of deductions in excess of
gross income. It is suggested that this approach would obviate the need
to require subjective determinations to be made concerning the tax-
payer's motive and the primary purpose for which the vacation home i?
held.
In addition, if there is any personal use of a vacation home, it has
been urged that the portion of expenses allowable to rental activities
should be limited to an amount determined on the basi-- of the ratio
of time the home is actually rented to the total time the vacation
home is used during the taxable year for all purposes (i.e., rental,
business, and personal activities).
The House bill
Under the House bill, if a vacation home is used by a taxpayer foi
personal purposes for the greater of 2 weeks or 5 percent of the actual
business use (that is its actual rental time), the deductions incurred
in connection with a vacation home, which would be allowed cannot
exceed the gross income from the business use of the vacation home.
These rules would not apply if the rental of a vacation home r e-ults in a
profit for the year.
In addition, where the 2 weeks or 5-percent rule applies, the deduc-
tions treated as being attributable to the rental activities would be
limited to the proportion which actual rental use bears to the total
actual use of the property (that is, business use plus personal use)
times the business expenses attributable to the vacation home (other
than expenses which are allowable in any event, such as interest and
taxes).
This provision would apply to taxable years beginning after Decem-
ber 31, 1975.
3. Foreign Convention Expenses
Present law
Generally, to be deductible, traveling expenses must be reasonable
and necessary in the conduct of the taxpayer's business and directly
attributable to the trade or business. If a trip is primarily related to
the taxpayer's business and the special foreign travel allocation rules
do not apply, the entire traveling expenses (including food and lodg-
ing) to and from a destination are deductible. If a trip is primarily
personal in nature, the traveling expenses to and from the destination
are not deductible even if the taxpayer engages in business activities
while at the destination.1 However, expense" incurred while at the des-
tination which are allocable to the taxpayer's trade or business are
deductible even if the transportation expenses are not deductible.
2 Treas. Reg. 1.183-2(b). Thee factors include: (1) The manner in which the
taxpayer carries on the activity, (2) the expertise of the taxpayer or his advisors,
(3) the time and effort expended by the taxpayer in carrying on the activity, (4)
the expectation that assets uqed in the activity may appr.i.i:.tc in vylue, (.i' the
success of the taxpayer in earring (,r, othcir similar or nisimilar activiti,-, (6) the
taxpayer's history of income or losses with rcspe ct to the active ity, (7) the amountof
occasional profits, if any, which are earned, (8) the financial tatis of the taxpayer,
and (9) the elements of personal pleasure or recreation.
SSee Paltersnn v. Thomas. 289 F. 2d 108 (5th Cir. 1061); Hpa,,iar Kaiia-,
T.C. M-emo 1973-95; Rev. Rul. 74-292, 1974-1 C.B. 43.
69-5?Y-T--7 1-- 2







With respect to expenses incurred in attending a convention or
other meeting, the test is whether there is a sufficient relationship
between the taxpayer's trade or business and his attendance so that
he is benefiting or advancing the interests of his trade or business.
Generally, deductibility depends upon the facts and circumstances
of each particular case. If the convention is for political, social, or
other purposes unrelated to the taxpayer's business, the travel
expenses are not deductible. The Internal Revenue Service has ruled
that the test for allowance of deductions for convention expenses
is met if the agenda of the convention or other meeting is so related
to the taxpayer's position as to show that attendance was for business
purposes.
If an individual travels away from home primarily to obtain edu-
cation for which the expenses are deductible as trade or business ex-
penses, the expenses for travel, meals, and lodging incurred while
away from home are deductible. However, the portion of the travel
expenses attributable to personal activities, such as sightseeing, is
treated as a nondeductible personal or living expense. If the travel
away from home is primarily personal, only the meals and lodging
incurred during the time spent in participating in educational pur-
suits are deductible.
Expenses of travel outside the United States are deductible only to
the extent they are allocable to the taxpayer's trade or business
or income-producing activities if the travel is for more than one week
or the time of travel outside the United States which is personal
is 25 percent or more of the total time on such travel. In the case of
foreign travel, this allocation requirement overrides the general rule
that the entire expenses of travel are deductible if the primary purpose
of the trip was related to a trade or business.
I8su
Questions have been raised as to the recent proliferation of con-
ventions, educational seminars, and cruises which are ostensibly held
for business or educational purposes, but which, it is alleged, are
held at locations outside the United States primarily because of the
recreational and sightseeing opportunities. The Internal Revenue
Service has announced that it intends to scrutinize deductions for
business trips, conventions, and cruises which appear to be vacations
in disguise. The Service noted that a number of professional, business
and trade organizations have been sponsoring cruises, trips and con-
ventions during which only a small portion of time is devoted to
business activity and that the practice seemed to be growing. In
cases where there are indications of abuse, the Service intends to
request lists of the names and addresses of the participants on cruises
and other trips. However, allowance of deductions claimed by partici-
pants would continue to depend upon the facts and circumstances,
including the relationship of the meeting to a particular taxpayer's
trade or business, as under present law.
As indicated above, the basic test applied by the Internal Revenue
Service is whether the convention or other meeting is primarily
related to the taxpayer's business or whether it is primarily personal
in nature. In administering this test, the Internal Revenue Service
is required to make a subjective determination as to the motives and
intentions of the taxpayer after taking into account all the facts and








circumstances in a particular case. One of the important factors con-
sidered by the Service in making this subjective determination
is the amount of time spent on business activities as compared to the
amount of time spent on personal activities. There are no specific
guidelines or formulae in the statute or regulations that specify when
this factor will weigh in favor of, or against the taxpayer. The tax-
payer is not required to keep detailed records relating to the amount
of time spent on each of these activities. Upon audit, the taxpayer
frequently attempts to substantiate the business nature of his trip by
providing the Service with the agenda from the meeting or a certifi-
cate of attendance which is furnished by the organization sponsoring
the meeting.2
The Service has indicated that the administrative problems created
by the lack of specific guidelines are substantial. The process of trying
to ascertain all the facts and circumstances is extremely time consum-
ing both for the taxpayer and the Service. It has been suggested that
it is particularly difficult for the Service because of the basically "all or
nothing" approach for transportation expenses under present law. If
the primary purpose is determined to be pleasure, no amount of the
travel expense can be deducted. Since reasonable and competent
auditors will differ in evaluating all the facts and circumstances, it is
suggested that the deduction of one taxpayer may be totally dis-
allowed while another taxpayer (perhaps with slightly different facts)
can obtain a complete deduction for travel expenses. This disparity
of treatment results in complaints that the Service does not treat
taxpayers equally.
Some believe that the lack of specific detailed requirements has
resulted in a proliferation of foreign conventions, seminars, cruises,
etc. which, in effect, amount to Government-subsidized vacations and
serve little, if any, business purpose. The promotional material often
highlights the deductibility of the expenses incurred in attending a
foreign convention or seminar and, in some cases, describes the meet-
ing in such terms as a "tax-paid vacation" in a "glorious" location. In
addition, there are organizations that advertise that they will find a
convention for the taxpayer to attend in any part of the world at any
given time of the year. It has been suggested that this type of promo-
tion has an adverse impact on public confidence in the fairness of the
tax laws.
The House bill
Under the House bill, a limitation would be imposed on deductions
allowable for the expenses of taxpayers attending conventions, educa-
tional seminars, or similar meetings outside the United States, its
possessions and the Trust Territory of the Pacific. Deductions would
be allowed for expenses incurred in attending not more than two for-
eign conventions per year. With respect to these two conventions, the
amount of the deduction for transportation expenses could not exceed
the cost of airfare based on coach or economy class. Transportation
expenses would be deductible in full only if more than one-half of the
total days of the trip (excluding the days of t transportation to and from
the site of the convention) are devoted to busine-4elaited activiti',-
2 A few organizations now maintain attendance records :Lnd rc(w".r. P.,rticipr,1tL
to "sign in" at each session of the convention or ecminiar.








If less than one-half of the total days of the trip are devoted to busi-
ness related activities, no deduction would be allowed for that portion
of the transportation expenses attributable to non-business-related
activities.
In addition, deductions for subsistence expenses, such as meals,
lodging, and other ordinary and necessary expenses, paid or incurred
while attending the convention would be limited to the fixed amount
of per diem allowed to government employees at the location where
the convention is held. However, in order to be able to deduct subsist-
ence expenses up to this limitation, there must generally be at least 6
hours of business-related activities scheduled daily and the taxpayer
must have attended two-thirds of these activities.
This provision would apply to conventions held after December 31,
1975.
4. Qualified Stock Options
Present law
An employee stock option is a relatively low risk'means of acquiring
an equity interest in a corporation, since the option need not be
exercised unless the value of the stock increases during the option
period. If the value of the stock drops below the price at which the
stock may be purchased (i.e., below the option price), the employee can
allow the option to lapse (although ordinarily the employee would lose
the amount which he may have originally paid for the option, if any).
Under present law, no income is recognized on the grant to a cor-
porate employee, or on his exercise of, a "qualified" option to receive
stock in the employer corporation. The stock acquired by the exercise
of the option is a capital asset in the hands of the employee and the
income realized from the eventual sale of the stock is generally treated
as long-term capital gain or loss.1
No deduction is available to the employer, as a business expense
with respect to either the granting of a qualified stock option or the
transfer of stock to the employee when he exercises a qualified option.
A qualified option must be granted pursuant to a plan approved by
the shareholders of the corporation. The option must, by its terms, be
exercised within 5 years from the date it is granted and the purchase
price of the shares (option price) may not be less than the fair market
value of the company's stock on the date when the option is granted
to the employee. In addition, any stock acquired under a qualified
option may not be disposed of within 3 years after it is transferred to
the employee. The option must also be exercised while the option
holder is an employee of the corporation, or within three months after
the termination of his employment.
By con t asAt, the value of a nonqualified stock option generally repre-
sents ordinary income to the employee if the option itself had a readily
ac.certainable fair market value at the time it was granted to the
employee. If the option did not have a readily ascertainable value
when granted, it would not constitute ordinary income at the time it
was granted but when it is exercised the spread between the option
Generally similar tax treatment is also available in the case of "restricted
stock options," which were the predecessors to qualified options, but restricted
stock options are no longer being granted, and most restricted options which
we.re granted in the past. have now been exercised or have lapsed.








price and the value of the stock at that time constitutes ordinary
income to the employee.
Although an employee does not have to pay tax under the qualified
stock option rules at the time he exercises the option and receives
,tock worth more than he paid for it, the bargain element is treated
as an item of tax preference under present law. This means that the
excess of the fair market value of the share at the time of exercise over
the purchase price paid by the employee is subject to the 10-percent
minimum tax under present law.
Issue
The principal reason for the present tax treatment of qualified stock
options is said to be that such treatment allows corporate employers to
provide "incentives" to key employees by enabling the-s* employees to
obtain an equity interest in the corporation. However, questions have
been raised as to whether a qualified stock option gives key employees
more incentives than do any other form of compensationT, especially
since the value of compensation in the form of a qualified option is
subject to the uncertainties of the stock market. It is also noted that
the market price of a company's stock is subject to many variables and
the connection between an employee's own efforts and the value of the
stock is, at best, speculative, particularly in the case of a large publicly
traded corporation with many employees. Moreover, to the extent
there is an incentive effect resulting from stock options, it is argued
that present law discriminates in favor of corporations (which are the
only kind of employers who can grant qualified options) as opposed to
all other forms of business organization.
Qualified stock options have become less attractive as a compensa-
tion technique in recent years because of the generally declining stock
market of recent years. The market price of stocks of many publicly
held companies has dropped substantially in the recent recession. As a
result, many qualified stock options granted in previous years at pur-
chase prices which seemed attractive on an assumption that the price
of the company's stock would rise became unattractive as the price of
the outstanding stock fell. Many executives thus had no incentive to
exercise their options which were "under water," i.e. options whose ex-
ercise price was higher than the current level of the company's stock
in the open market. Because of this loss-of-incentive feature many
companies have turned to other techniques and plans a. a way to
compensate their executives.
Some companies, however, have gone ahead and granted new quali-
fied options to their executives at the currently depre-!(d market
prices of their stock. The rationale has been that the executives may
still be able to benefit by the new options if the price of the stock does
increase in the years ahead and if the executives do not have to wait
too long to exercisee the new options. In some casc such new grants of
qualified stock options to executives in the rece-sion has produced
inc'reasing critici-m from the shareholders of the companies;. Some such
shareholders have argued that the grant of new qualified options
enables the companies' executives to avoid talking the same businm:-s
ri-ks that the shareholders generally are taking with rcg: rd to the
company's fortunes.






10


The House bill
Under the House bill, in the future, qualified stock options would be
subject to the same rules as presently apply in the case of most non-
qualified options. Generally, the value of the option would constitute
ordinary income to the employee if it had a readily ascertainable fair
market value at the time it was granted (and was not nontransferable
and subject to a substantial risk of forfeiture). If the option did not
have a readily ascertainable value, it would not constitute ordinary
income at the time it was granted, but when the option was exercised
the spread between the option price and the value of the stock would
constitute ordinary income to the employee.
In general, the new rules would apply to options granted after
September 23, 1975, but would not apply to options granted on or
before this date. This is true even though the option is exercised in the
future (so long as it meets the terms of the present rules of a qualified
option). In addition, transition rules would be provided for options
granted after September 23, 1975, pursuant to a written plan adopted
and approved before September 24, 1975; for options granted after
September 23, 1975, under a qualified plan adopted by a board of
directors before September 24, 1975, even if the plan was approved by
the shareholders after that date; and for substitute options granted
after September 23, 1975, as a result of a corporate reorganization or
similar transaction provided that no modification of the former option
occurs. The transition rules cover these options as long as they are
exercised before September 24, 1980.
These rules would apply to taxable years ending after September 23,
1975.

5. Treatment of Losses From Certain Nonbusiness Guaranties
Present law
Under present law, in the case of a noncorporate taxpayer, business
bad debts arc deductible as ordinary losses for the year in which the
debt becomes worthless or partially worthless. On the other hand, non-
busine.ss bad debts are treated as short-term capital losses, which
means that the losses are offset first against the taxpayer's capital
gains (if any), and may then be deducted against ordinary income
to the extent of $1,000 per year.
However, where the noncorporate taxpayer's loss results from a situ-
ation where he guaranteed the debt of a noncorporate person, and was
required to make good on that guaranty because the borrower de-
faulted, present law provides that the guarantor may treat the pay-
ment under the guaranty as a business bad debt (even though the
guaranty did not arise in connection with the guarantor's trade or
business) if the proceeds of the loan were used by the borrower in
his trade or business. However, the guarantor of a corporate obligation
which becomes worthless must treat the guaranty payment as a non-
business bad debt.
If the loan is not used in the borrower's trade or business, the
guarantor's payment will still be deductible as a nonbusiness bad
debt (short-term capital loss) if the debt is worthless when paid and
the guarantor lhas a right of reimbursement (subrogation) against the
borrower.'








In cases where the guarantor has no right of subrogation, there has
been some uncertainty as to whether, and under what circumstances,
the g'iarantor was entitled to deduct his guaranty payment. For some
time it was believed that the payment could not be deducted as a bad
debt on the theory that unless there is a right of recovery against the
borrower, there is no "debt" which might become worthless in the
hands of the guarantor. However, if the guaranty transaction was
entered into in connection with the taxpayer's trade or business, or the
agreement was part of a transaction entered into for profit on the part
of the taxpayer, then the payment was thought to be deductible as a
loss under section 165.
Recently, courts have found an implied promise on the part of the
borrower to reiirburse the guarantor for his payments, and holding
that this implied promise constituted the bad debt.2 Thus, taxpayers
were required to claim their deduction under section 166. However,
there is no assurance that the rationale of these cases will be appli-
cable in all fact situations where there is potential for avoidance of
the bad debt rules, or that these opinions will be followed in every
jurisdiction.
Issue
As discussed above, where a taxpayer makes a loan which is not
connected with his trade or business, and the debt becomes worthles-,
he is generally required to treat the loss as a Thort-term capital loss.
On the other hand, it is pointed out that where the taxpayer and the
borrower can persuade a third party to make the loan, which is
guaranteed by the taxpayer, and the proceeds of the loan are used by
the borrower in his trade or business, the loss, if one results, may
generally be deducted by the taxpayer against ordinary income.
Questions have been raised as to whether this distinction makes -ense.
It appears to provide a tax incentive for careful planning, pZrticularly
in transactions between closely related parties, such as family mem-
bers, with no emphasis on the actual substance of the loan transaction.
Another issue is whether there should be clarification in the case of
a guarantor of a corporate obligation that any payment under the
guaranty agreement must be deducted as a nonbusiness bad debt,
regardless of whether there is any right of subrogation, unless the
guaranty was made pursuant to the taxpayer's trade or business.
The House bill
Under the House bill, where a taxpayer has a lo-s arising from the
guaranty of a loan, he would receive the same treatment as where he
has a loss from a loan which he makes directly. Thus, if the guaranty
agreement arose out of the guarantor's trade or business, the giir-,Intor
would still be permitted to treat the lo:-s as an ordinary lo-s. If the
guaranty agreement were a transaction entered into for profit by the
guarantor (but not as a part of his trade or business), he would treat
the loss as a short term capital loss. This rule would al-o apply in
the case of a guarantor of a corporate obligation.
These rules would apply to taxable years beginning after December 31,
1975.
I If the debt is not worthless, no deduction is generally allowed (on the theory
that payment by the grantor was voluntary).
2 See e.g., Bert W. Martin, 52 T.C. 140 (reviewed by the Court), aff'd per curianim,
424 F. 2d 1368 (9th Cir.) cert. denied, 400 U.S. 902 (1970).






12


6. Away From Home Expenses of State and Congressional
Legislators
Present. law
Under present law, an individual is allowed a deduction for travel-
ing expenses (including amounts expended for meals and lodging)
while away from home in the pursuit of a trade or business. These
expenses are deductible only if they are ordinary and necessary in
the taxpayer's business and directly attributable to it. "Lavish or
extravagant" expenses are not allowable deductions. In addition, no
deductions are allowed for personal, living, and family expenses except
as expressly allowed under the code.
Generally, expenses and losses attributable to a dwelling unit which
is occupied by a taxpayer as his personal residence art not deductible.
However, deductions for interest, taxes, and casualty losses attrib-
utable to a personal residence are expressly allowed under other
provisions of the tax laws.
A taxpayer's "home" for purposes of the deduction for traveling
expenses generally means his principal place of business or employ-
ment. Where a taxpayer has more than one trade or business, or a
single trade or business which requires him to spend a substantial
amount of time at two or more localities, his "home" is held to be at
his principal place of business. A taxpayer's principal place of business
is determined on an objective basis taking into account the facts and
circumstances in each case. The more important factors to be con-
sidered in determining the taxpayer's principal place of business (or
tax home) are: (1) the total time ordinarily spent by the taxpayer at
each of his business posts, (2) the degree of business activity at each
location, (3) the amount of income derived from each location, and
(4) other significant contacts of the taxpayer at each location. No one
factor is determinative.
In 1952, a provision was adopted with respect to the living expenses
paid or incurred by a Member of Congress (including a Delegate or
Resident Commissioner). Under these rules, the place of residence of
a Member of Congress within the congressional district which he
represents in Congress is considered his tax home. However, amounts
expended by the Member within each taxable year for living expenses
are not deductible in excess of $3,000. Therefore, a Member of Con-
gress (who does not commute on a daily basis from his congressional
district) 1 can deduct up to $3,000 of his expenses of living in the
Washington, D.C. area.
These rules do not apply in the case of a State legislator. As a
result, the tax home of a State legislator is determined in accordance
with the general rules described above. In a situation where a State's
legislature is in session for a significant portion of the year, that State's
legislators' homes, may, under these rules, be at the State capital rather
than in their legislative districts.
Issu18e
In recent years, the sessions of many State legislatures have been
substantially lengthened. As a result, members of the various legisla-
tures are required to spend substantial portions of each year in the
1 Under the "overnight rule," travel away from home expenses (as distinguished
from transportation expenses) generally cannot be deducted unless the taxpayer
is away from home on business overnight.








State capital. In order to reimburse the legislators for the living
expenses incurred in connection with attending sessions in the State
capital, many legislatures provide a per diem for each day a legislator
attends a session of the legislature.
It is stated that it is extremely difficult for many State legislators
to determine their tax homes under the facts and circumstances test
of present law. First the length of time that a State legislature is in
session may vary substantially from year to year. Moreover, several
State legislatures meet only once every two years. In addition to the
variation of time, a legislator's income derived from his place of
residence and from the State capital will frequently vary. This
problem is heightened by the fact that the Interm-al Revenue Service
will not issue an advance ruling determining an individual legislator's
tax home.
Consistent with their prior practice, many State legislators have con-
tinued to treat their residences in the districts they represent as their
tax homes and have filed their Federal income tax returns in accord-
ance with this practice, thereby deducting living expenses incurred
in the State capital. The Service is currently challenging this practice
and determining the tax home of a State legislator on a case-by-case
basis. In some cases, this has resulted in a determination that the
legislator's tax home is the State capital and in other cases, that his
tax home is in the district he represents. If the Service determines
that a legislator's tax home is the State capital, deductions taken for
living expenses incurred in connection with the time spent at the
State capital are disallowed. Although a deduction will then be
allowed for living expenses incurred in the district the State legislator
represents, in many cases the taxpayer (not having kept records
of these expenses since they were not thought to be deductible) will
not be able to substantiate those expenses. Many state legislators
consider this inconsistent treatment and view the results as inequitable.
Furthermore, many believe that the $3,000 limitation (established
in 1952) on the deductions for living expenses of Members of Congress
in the Washington, D.C., area is inappropriate since this is much less
than is generally allowed in the case of busine-s employees who are
away from home on business overnight. Under present law, if an em-
ployer reimburses an employee for subsistence or provides an em-
ployee with a per diem allowance in lieu of subsistence, the employee
may generally deduct up to $44 per day for subsistence expenses
incurred in connection with travel away from home (on behalf of his
employer) without the requirement of substantiation. It is argued that
legislators (both State and U.S.) should be entitled to treatment
similar to that accorded other businessmen under present law.
The House bill
Under the House bill, for purposes of the deduction of trade or
business expenses away from home by a State legislator, the home of a
State legislator would be his place of residence within the legislative
district which he represents. Deductions by a State legislator would be
limited to an amount determined by the Internal Revenue Service.
The IRS would apply rules of reasonableness and would tlke into
account certain factors such as the number of days of legislative par-
ticipation, the cost of living at the place where the legislature meets






14


and the amounts normally allowed businessmen under similar cir-
cumstances. An election would be provided for State legislators with
respect to past periods.
Further, under the House bill, the $3,000 limitation would be
modified to provide that deductions by a Member of Congress would
be limited to an amount determined by the Internal Revenue Service.
The IRS would apply rules of reasonableness and would take into
account certain factors such as the number of days that the Members
are away from home, the cost of living in Washington, D.C., and the
amounts normally allowed businessmen under similar circumstances.
These provisions would apply to taxable years beginning after
December 31, 1974.
0




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