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May 1990

Omnibus Budget Reconciliation Act of 1989 - finding trends in the confusion.

by O'Connor, Walter F.

    Abstract- The Omnibus Reconciliation Act of 1989 is confusing, lacks a central theme, and appears to be an attempt to increase revenue instead of to reform taxation. The areas covered by the major provisions of the act include: the consolidation and rationalization of penalty provision; the closure of loopholes related to business; and taxpayer relief. The penalties areas covered include consolidation of negligence, fraud, and valuation; delinquency; and information reporting. The areas falling under the closure of loopholes include: research and development credit; permissibility of hybrid percentage of completion; and franchises, trademarks, and tradenames. The areas falling under taxpayer relief include: corporate alternative minimum tax; tax exempt bonds; and low-income housing credit.

Most revenue from the omnibus Budget Reconsiliation Act of 1989 (OBRA 89) will be raised by limiting the tax benefits in corporate restructuring and takeovers, restricting the tax advantages of employee stock ownership plans (ESOPs), extending certain excise taxes, and accelerating corporate deposits of payroll taxes. Several provisions aimed at business will also affect certain individual taxpayers.

There are not many policy issues involved. However, the corporate alternative minimum tax (AMT) provisions are somewhat liberalized, and the penalty structure is made more orderly. Readers interested in those areas should further research the details of OBRA 89.




A major policy change has been made in the area of penalties. Indeed, the amount of revenue from penalties had grown so that it raised the question of whether penalties were intended to change behavior, or were, in reality, a major source of revenue. The issue was heightened by the substantial understatement penalty in Sec. 6661 in connection with positions taken on tax return filings. OBRA 89 segments the penalty situation into specific areas.

Consolidation of Negligence,

Fraud, substantial

Understatement, and

Valuation Penalties

These penalties have been consolidated into a single, " accuray- related" penalty, imposed at a uniform rate of 20%. It applies to the portion of any understatement attributable to negligence or intentional disregard of rules or regulations, substantial understatement of income tax, substantial valuation overstatement, substantial overstatement of pension liabilities, and substantial estate and gift tax valuation understatements. These accuracy-related penalties are coordinated with the fraud penalty which remains at 75%.

Under a fairly standard exception, no accuracy-related penalty will be imposed for an underpayment if reasonable cause is shown and the taxpayer acted in good faith. In addition, the Committee reports clarify that a full and substantive disclosure on the tax return of a non-frivolous position would be an exception to the so-called negligence components of the accuracy-related penalty.

If an underpayment of tax is attributable to negligence, the penalty will apply only to the portion of the underpayment attributable to negligence, rather than to the entire underpayment, as under prior law.

There also has been a meaningful change in the factors to be considered in the determination of substantial understatement. The IRS as been directed to expand the list of authorities upon which taxpayers may rely to include proposed regulations, private latter rulings, technical advice memoranda, actions on decisions, general counsel memoranda, information or press releases, notices, and any documents published in Internal Revenue Bulletins. Furthermore, general explanations of tax legislation prepared by the Joint Committee on Taxation (often referred to as the Blue Book) will be considered substantial authority. Many of these items were not so considered under TRA 86.

Finally, to assist taxpayers in determining whether an issue should be disclosed on a return, the IRS is required to publish an annual list of positions for which it believes there is no substantial authority.

With regard to penalties attributable to a substantial valuation overstatement, the rules have been modified as follows:

* The penalty is expanded to all taxpayers;

* A substantial valuation overstatement will be considered to exist if the value or adjusted basis is 200% or more of the correct amount;

* The penalty is 20% of the amount of the underpayment if the value or the adjusted basis is 20% or more but less than 400% of the correct amount. The penalty is doubled to 40% if the value or adjusted basis claimed is 400% or more of the correct amount.

These changes apply to returns whose initial due date for filing is after December 31, 1989.

Preparer and Promoters Held

to a Higher Standard

OBRA 89 contains a "realistic possibility" standard which is consistent with the professional conduct standards applicable both to CPAs and attorneys. This stems from a compromise between the IRS and the accounting and legal professions.

OBRA 89 provides that an income tax preparer is subject to a $250 penalty if any part of a tax understatement on a return is attributable to a position that the preparer knew, or reasonably should have known, that there was not a realistic possibility of being sustained on its merits, and the position was not considered to be frivolous. The penalty will not be imposed if there was reasonable cause and the preparer acted in good faith.

There is a penalty of $1,000 per activity for directly and indirectly promoting abusive tax shelters. There is also a penalty for aiding and abetting an understatement of tax liability. It is imposed when a person advises a taxpayer with respect to any portion of a tax return or other document and that person knows the document will be used in connection with a material tax matter and also knows that its use would result in an understatement of the tax liability of another person.

These penalty situations heighten the responsibility of the tax advisor and preparer. They apply to documents prepared after December 31, 1989.

Delinquency Penalties Will

Cost More

If the failure to file a return is found to be fraudulent, the penaty is 15% of the net amount of tax due for each month the return is not filed up to a maximum of 75%. In this case the IRS has the burden of proof for the fraud portion of this penalty, under Sec. 7454(a).

This penalty increase applies to returns whose initial filing due date is after December 31, 1989.

Standards for Imposing

Information Reporting

Penalties are Revamped

Under OBRA 89, any failure to timely file a complete and accurate information return is subject to a penalty that depends on when the correct return was filed. If a correct return is filed within 30 days of the required filing date, the taxpayer will be subject to a $15 penalty; there is a maximum penalty of $75,000 per calendar year. Where the correct information is filed after 30 days but before August 2, the penalty is $30 with a maximum of $150,000 per calendar year.

Failure to file the correct information return before August 2 subjects the taxpayer to a $50 penalty, with a maximum of $250,000 for a calendar year.

These provisions result int eh elimination of the special rules applicable to interest and dividend information returns. Therefore the ability to impose unlimited penalties is removed and the due diligence standard is replaced with the reasonable cause waiver. The requirement to self assess penalties (i.e. Form 8210) no longer applies.

Other changes to the information reporting provisions include: 1) special lower maximum penalties for small businesses; 2) the retention of increased penalties for intentional disregard of the filing requirements; and 3) a uniform threshold requirement for the use of magnetic media to all information return filings.

These revised information return penalties apply to returns and statements required to be filed after December 31, 1989.




The definition of a loophole is still dabatable. The following issues, however, do identify tightening of code sections to raise revenues. You can be the judge.

The Research and

Experimental (R&D) Credit is

Extended but Reduced

The R&D tax credit generally is extended for expenditures incurred before January 1, 1991, continuing the practice of annual extensions of the R&D credit. For taxalbe years beginning October 1, 1990 and ending after September 30, 1990 (e.g., calendar 1990), the amount of qualified research expense is limited to a percentage equal to the ratio of the number of days in the taxable year before October 1, 1990, to the total number of days in the taxable year before January 1, 1991.

The R&D credit provisions are modified in the way taxpayers must compute base period research expenses. Previously, the base period figures were determined primarily by utilizing actual R&D expenses for the base period years. The new determination is based on the ratio of: the taxpayer's aggregate qualified research expenses for taxable years beginning after December 31, 1983, and before January 1, 1989, to the taxpayer's aggregate gross receipts for such years. This new "fixed-base percentage" is then multiplied by the taxpayer's average gross receipts for the four taxable years preceding the current year for use in determining the R&D credit for the current year. The fixed based percentage is limited to 16% for companies that have been in existence for the period needed for the computations. For companies just getting started, the fixed based percentage is considered to be 3%.

Essentially the new method limits the R&D credit based upon the overall growth of the company as measured by gross receipts. In addition, there is still the same limitation found in the current law whereby a taxpayer's base amount cannot be less than 50% of its current year qualified research expenditures.

There is a further constraint in that any deduction allowed for qualified research expenditures must be reduced by 100% of the credit determined for the year using the method previously described.

The R&D credit changes are for years beginning after December 31, 1989.

Permissibility of Hybrid

Percentage of Completion

Method is Severely Curtailed

The hybrid percentage of completion/capitalized cost method of accounting for long-term contracts is repealed. However, the exceptions relating to contracts for certain construction activities of small businesses, qualified shipbuilding, and residential construction are retained. Those not meeting the exception are required to use the percentage of completion method.

All taxpayers may elect not to recognize income at the end of a taxable year under the percentage of completion method where less than 10% of the total estimated contract costs have been incurred. While OBRA 89 provides an effective date of July 11, 1989, for this 10% method, the Conference Report indicates that the election is effective for contracts entered into after December 31, 1989. It is important to be aware of this inconsistency.

Deductions for Franchises,

Trademarks, and Tradenames

May Have to be Taken Over a

Longer Period

OBRA 89 changes the rules for the deduction of fixed sum payments and contingent payments for a frachsie, trademark or tradename.

* It repealed the special deduction treatment if the payments exceed $100,000;

* Contingent payments may continue to be deductible provided that they are paid at least annually and are substantially equal in amount or based on a fixed formula;

* Fixed and contingent payments not deductible under these rules are eligible for amortization over a 25-year period; and

* Sec. 167(r), added by TAMRA, is repealed, which had denied depreciation or amortization deductions for costs of acquiring trademarks or tradenames.

These provisions are effective for transactions occuring after October 2, 1989.

Listed Property Expanded to

Include Cellular Telephones

and Other



Cellular telephones and other telecommunications equipment have been added to the definition of "listed property," which means, among other things, tht depreciation deductions are subject to limitations based on percent of business use. The major reform issue is the growing number of listed properties, with cellular telephones now joining automobiles and entertainment facilities. The effective date is for property placed in service or leased after December 31, 1989. This is an area for tax practitioners to watch in future legislation.

Corporate Debt/Equity Issues


What is Debt and What is Equity? OBRA 89 clarified the Treasury's ability to characterize an instrument as part debt and part equity. The Treasury has been directed to accumulate information about corporate acquisition and capitalization transactions occurring after March 31, 1990. As a result, taxpayers can anticipate positions from the IRS that are not limited to finding an obligation as either debt or equity in its entirety. Instead, a "piecemeal" approach to dissect instruments into segments of debt and equity can be expected.

Bifurcation of High Yield OID Obligations Changes Portion of Interest to Dividend. In an interesting twist to the treatment of original issue discount (OID), OBRA 89 now treats part of the income from such obligations as interest and part as dividends. From the standpoint of the issuer, the yield is split into and interest element deductible only when paid and a return on equity element for which no deduction is available. This latter portion is called "disqualified yield" and consists of the amount of the yield that exceeds an applicable federal interest rate plus six percentage points. This provision applies to OID of any C corporation debt that has: 1) a term of more than five years; 2) significant OID; and 3) a yield in excess of five percentage points over the applicable federal rate. With this new bufurcation concept, it appears Congress has taken an aim on junk bonds in a manner which separates such bonds into different types of financial instruments for tax purposes.

This provision is generally effective for instruments issued after July 10, 1989.

Extraordinary Dividend Concept Expanded. OBRA 89 has expanded the extraordinary dividend concept of Sec. 1059. Certain distributions to shareholders are treated as extraordinary dividends requiring a reduction in basis where: 1) the stock has a declining dividend rate when issued; 2) the stock's issue price exceeds its liquidating rights; or 3) the stock is structured so as to enable corporate shareholders to reduce tax via a combination of dividend received deductions and losses on dispositions.

Generally, this provision applies to stock issued after July 10, 1989.

Securities Received in Sec. 351 Transactions Would be Boot. OBRA 89 impacts the tax-free treatment previously available to securities in Sec. 351 transactions by treating debt securities as boot. This prevents taxpayers from getting around the installment sales reporting rules in general, and the pledging of installment receivables in particular. Treating receivables as boot means tht the use of Sec. 351 as an alternative divestiture planning tool will be greatly limited.

These provisions generally apply to transfers after October 2, 1989.

New Restrictions on Use of


NOL Carrybacks Following a CERT are Limited. If a corporation has an NOL in a taxable year in which it is involved in a corporate equity reduction transaction (CERT), the corporation's ability to carryback some portion of the NOL will be limited. Congress was concerned about corporations carrying back NOLs created by leveraged buyouts (LBOs). The portion of NOL carryback so limited is the lesser of the corporation's interest expense attributable to the CERT or the excess of the corporation's interest expense in the loss limitation year over the average of its interest expense for the last three years. There is also a de minimis relief provision limitation for amounts less than $1 million. It is obvious that this provision is geared for the larger LBOs. These rules are generally effective with respect to CERTS occurring after August 2, 1989.

Use of NOL Against Earnings of Subsidiary Issuing Preferred Dividends is Also Limited. Prior to OBRA 89, preferred dividends could be paid by a corporation that joined with others in a consolidated return, and the receiving corporation (outside the consolidated return group) would be entitled to a dividend received deduction, regrdless of the fact that the taxable income of the paying corporation might have been completely eliminated by NOLs of other corporations joining in the consolidated return. OBRA 89 disallows the offset of the NOL in the consolidated return up to the amount of the preferred dividends paid to non- affiliated corporations.

This provision generally applies to IRC Sec. 1504(a)(4) stock issued after November 17, 1989.

Built-in Gains and Losses Further Restricted. Secs. 382 and 384 restrict a corporation's ability to use built-in gains and losses. OBRA 89 now makes it even tougher, since it reduces the threshold levels at which these rules kick in. Under the new rules, restrictions apply if the built-in gains or losses exceed the lesser of 15% of the far market value of the company's assets or $10 million. The same threshold levels apply for corporate AMT purposes.

In the past, the thresholds were always a concern for larger corporations; smaller companies with a relatively small amount of built- in losses now could be subject to Secs. 382 and 384.

These provisions are generally effective for ownership changes and acquisitions after October 2, 1989, in tax years ending after that date.

Recapture of Excess Loss Account No Longer Postponeable by Offset Against Debt. Prior to OBRA 89, a parent corporation that had an excess loss account in its subsidiary's stock could elect to use the excess loss to reduce the basis of debt held after disposition of the stock. OBRA 89 modified the excess loss account recapture rules to prevent a reallocation of the excess loss account to reduce the basis of debt in the subsidiary held by the parent after the disposition of the subsidiary's stock.

This rule is generally effective for dispositions made after July 10, 1989, in tax years ending after that date.

Property Received in Like-Kind

Exchanges Between

Related Parties Now Subject to

a Holding Period to Preserve


OBRA 89 has amended Sec. 1031 so that in the case of like-kind exchanges on a tax-free basis between related parties, neither party may dispose of the property received within two years. If such a disposition takes place, all previously unrecognized gain with respect to the exchange will be recognized as of the date of the disposition. This provision applies generally to transfers after July 10, 1989.

Foreign Real Estate No Longer

Qualifies for Like-Kind

Treatment with U.S. Property

Foreign and U.S. real estate are not considered like-kind under Sec. 1031 for exchanges after July 10, 1989.

Gain May Be Triggered on

Certain Partnership


While the distribution of property from a partnership to a partner is normally a nontaxable event, OBRA 89 indicates that when such a distribution involves property acquired by the partnership as a capital contribution from a partner other than the one to whom the property is distributed, the pre-contribution gain or loss in the property must be recognized by the contributing partner. There are two exceptions. First, the provisions will not apply if the distribution is made more than five years after the property was originally contributed. Second, no gain or loss will be recognized if certain like-kind property is distributed to the contributing partner within 180 days of the first distribution. Since these techniques were often used in high technology and oil and gas exploration development activities, the use of partnership forms for those industries is apt to have more limited use.

These provisions apply to property contributed to a partnership after October 3, 1989, in tax years ending after that date.

Mutual Fund Changes Will

Yield More Tax Revenues

Several changes affecting regulated investment companies (RIC) have been instituted. They involve the amount of ordinary income an RIC must distribute to avoid the penalty excise tax; the ability to get a tax benefit for the payment of an upfront load charge when investing in a mutual fund is limited; the role of the record date for a dividend in determining when a mutual fund must include the dividend in income; and the exemption of mutual fund indirect expenses from the 2% floor for miscellaneous itemized deductions is made permanent.



While not many in number, there are some provisions easing taxpayer burdens.

Corporate Alternative

Minimum Tax (AMT)

An area of controversy with AMT has been the use, for tax years ending before January 1, 1990, of book income in determining AMT taxable income. The new law retains the separate adjusted current earnings (ACE) concept for corporations as a substitute for book income, effective for taxable years beginning after December 31, 1989. OBRA 89 has attempted to simplify the computation by eliminating the requirement to use the book method of treating depreciation, intangible drilling costs, and mining exploration and development costs where they provide smaller write-offs. OBRA 89 also makes changes in determining ACE in areas involving the income from discharge of indebtedness, the dividend received deduction, gains on installment sales, the separate ACE rules for capitalizing and amortizing construction periods carrying charges (because the UNICAP rules will apply), the writedown of assets in the case of certain ownership changes of the corporation, the amortization period for intangible drilling costs, the capitalization and amortization of acquisition expenses of life insurance companies, and rules involving guidance on the determining earnings and profits.

The corporate AMT rules are also changed in the area of minimum tax credits with the credit eligible to be carried over based on the entire AMT rather than only the portion not attributable to exclusion-type adjustments and preferences (e.g., tax exempt interest). OBRA 89 also makes two liberalizing technical corrections, one dealing with the minimum tax credit available to an S corporation and the other in connection with the use of AMT paid because of the 90% foreign tax credit limitation.

The corporate AMT relating to long-term home construction contracts has been liberalized. Taxpayers with such contracts are exempt from computing income under the percentage of completion method for AMT purposes.

Arbitrage Exceptions on

Certain Tax Exempt Bonds are


OBRA 89 extends to two years the six-month exception for application of the arbitrage rebate rules for certain bonds issued after the date of enactment. Bonds that are not private activity bonds and qualified Sec. 501(c)(3) bonds generally will qualify for this extended exception if at least 75% of the net proceeds of the issue are used for construction and certain other spending thresholds are met.

Expiration Dates Extended,

but Not All for a Full Year

OBRA 89 continues the extension of certain provisions on almost a year-to-year basis. The extensions relate to provisions considered worthwhile but that have the detriment of using up revenues. However, OBRA 89 extends many items only until September 30, 1990, the end of the federal fiscal year. For this reason, the expiration dates for the following items should be carefully noted: the targeted jobs tax credit, the authority of state and local governments to issue tax exempt mortgage subsidy bonds and mortgage credit certificates, the authority to issue qualified small issue manufacturing bonds, and the business energy tax credit.

Low Income Housing Credit

Extended and Liberalized

The low income housing credit has been extended through December 31, 1990. OBRA 89 has made significant modifications to credit eligibility requirements. They include:

* Restrictions on the availability of the credit for acquisition of existing buildings;

* An increase in the minimum qualifying expenditure requirements for rehabilitation projects;

* A change in the determination of eligible basis of acquired property to conform it to that of newly constructed property;

* The denial of credit for units of substandard quality that are not suitable for occupants;

* The allowance of the credit for certain transitional housing for the homeless;

* The modification of rules relating to rent restrictions;

* The requirement for a 30-year extended low income use agreement after the compliance period; and

* A clarification that owners may provide low income tenants with the right of first refusal to purchase the property at the end of the compliance period without affecting tax benefits associated with the credit.

Perhaps realizing that low income housing is primarily of interest to investors with higher gross incomes, OBRA 89 has eliminated the phaseout of the $25,000 deduction equivalent exemption under the passive loss rules for individual taxpayers that have higher adjusted gross incomes. This provides a planning opportunity for taxpayers who heretofore found low income housing investments unattractive because of the phaseout based on adjusted gross income.



ESOPs have been a particular target of attention given the situation that some federal legislators feel they are being used for purposes other than those originally intended. This perhaps has come about in part through their use in thwarting hostile takeovers.

Interest Exclusion Restricted

In connection with the ESOP interest exclusion, the 50% exclusion available to qualified lenders who make securities acquisitions loans has been limited. Now interest will be excludable only if the ESOP owns 50% or more of the outstanding stock of the corporation. The exclusion is also not available when the ESOP ownership falls below the applicable percentage threshold.

New Excise Tax Imposed

OBRA 89 also imposes a new excise tax on the employer equal to 10% of the fair market value of the stock if the employer securities acquired with the securities acquisition loans are not held for at least three years.

New Reporting Requirements


To make sure that taxpayers comply with the ESOP rules, an employer maintaining the plan, or any person making a securities loan, must comply with reporting requirements to be prescribed.

Dividend Deduction


An employer may deduct dividends on its securities held by an ESOP only if paid directly in cash to the plan participants or paid with respect to employer securities acquired before August 4, 1989.

Other Rules Tightened

In addition, OBRA 89 makes the following tightening of the ESOP rules:

* Repeals the estate tax deduction for certain sales of employer securities to an ESOP;

* Eliminates non-recognition treatment for gain on the sale of employer securities which have not been held for at least three years by an ESOP;

* Repeals the special rule allowing an ESOP to assume a portion of the estate tax liability of the estates of individuals;

* Eliminates the special rule that increased the dollar amount that could be contributed for an ESOP participant to $50,000; and

* Eliminates a special rule to the effect that ESOP stock generally can no longer be considered unissued to determine whether an ownership change has occurred for purposes of using NOL carry-overs following a change of ownership.

The rules for ESOPs have been significantly changed, with many differing effective dates, and will require closer study by corporations of all sizes.




The provisions of OBRA 89 affecting international operations are almost equally balanced between negative provisions for foreign companies doing business in the U.S. and negative provisions for U.S. companies doing business abroad. In essence, Congress has determined the plethora of provisions dealing with outbound investments now is to be matched by complicated negative provisions dealing with inbound investments.

Earnings Stripping Provision

Attacks U.S. Subsidiaries of

Foreign Parents

OBRA 89 contains a provision that defers a deduction for interest paid or accrued by a U.S. corporation to a related party, if the latter is not fully subject to U.S. income tax on the interest income. The definition of recipients to which this provision applies now includes foreign corporations lending money to U.S. subsidiaries. As a result, where the paying corporation's debt to equity ratio exceeds 1.5 to 1, the deduction for related party interest will be deferred to the extent that total interest expense (reduced by taxable interest income) exceeds 50% of the corporation's adjusted taxable income (ATI) plus the amount by which this 50% income limit has exceeded net interest expense in the prior three years. For this purpose, ATI is taxable income of the corporation prior to reduction for interest expense, NOL, depreciation, amortization, and depletion.

The objective of this provision is to attack what Congress felt was the ability of foreign corporations to strip earnings out of U.S. subsidiaries in a way that resulted in a deduction at the subsidiary level, but with not ax paid at the parent corporation level.

This type of provision may clash with the thinking of some tax treaty countries. While the Committee Reports indicate that the provision does not conflict with U.S. tax treaties, it remains to be seen how this and certain provisions of TRA 86, which also had tax treaty implications, will fare when the move through the U.S. courts.

More Reporting Requirements

for Foreign Persons

As part of its growing interest in taxing foreign companies in the U.S., Congress sees the need for getting additional information about such potential taxpayers. OBRA 89 has increased information reporting as follows: 1) the stock ownership threshold requiring reporting by foreign owned corporations is reduced to 25% from 50%; 2) books and records are required to be maintained in the U.S.; 3) foreign persons (related to and engaging in any transaction with the foreign owned corporation that is subject to reporting requirements) must designate the reporting corporation as their agent for IRS summons procedures; 4) penalties for failure of foreign owned corporations to satisfy reporting and documentation requirements have been increased; and 5) in the event of noncompliance with summons procedures, the IRS has sole discretion to determine deductions or cost basis of property of the reporting corporation with respect to reportable transactions.

Taxable Years of Controlled

Foreign Corporations

Conformed to U.S.


A common planning technique had been to delay the application of tax law changes by electing taxable years for controlled foreign corporations (CFCs) so that their taxable years ended at the latest possible date. To close the loop, OBRA 89 provides that similar results apply for foreign corporations controlled by U.S. shareholders. Now where a single U.S. shareholder owns more than 50% of the voting power or value of the stcok of a CFC, the same taxable year must be adopted for the CFC as th at of the majority owner. With slight variations, similar rules apply to foreign personal holding companies.

R&D Expenditures Still

Negatively Impact Foreign Tax

Credit Calculations

A dispute has developed in recent years about the allocation of R&D expenditures in the computation of the foreign tax limitation. The allocation to foreign source gross income of a significant degree of R&D expenditures has had a negative effect on the foreign tax credit limitation. The matter is still not fianlly resolved by OBRA 89, but a compromise has been made for taxable years beginning after August 1, 1989 and before August 2, 1990. The expenditures for those periods must be allocated for income sourcing purposes as follows: 64% of the R&D expenditures where research is conducted in the U.S. must be allocated to U.S. source income, and 64% of R&D expenditures for research conducted outside the U.S. must be allocated to foreign source income. The remaining 36% of the R&D expenditures must be apportioned between U.S. and foreign source income on the basis of either sales or gross income of the U.S. taxpayer. OBRA 89 enacted specific rules for the treatment of R&D expenditures attributable to the first nine months of the taxable year.

Resourcing Now Required for

Foreign Tax Credits in

Consolidated Returns

OBRA 89 gives the IRS authority to issue rules for sourcing the income of affiliated corporations not participating in a consolidated tax return. This is done to prevent the avoidance of the foreign tax limitation provisions. It applies where corporations have restructured their consolidated returns to remove certain corporations that have a high ratio of expenses to foreign source gross income.

Foreign Tax Credit Received

for "Baker 33" Countries Now


OBRA 89 repeals a transition rule of TRA 86 that granted beneficial treatment for foreign tax credit purposes to interest received on loans to certain less developed countries, known as "Baker 33" listed countries. This provision applies to taxable years beginning after December 31, 1989. A relief provision exists for taxpayers (e.g., banks) that, for regulatory reporting requirements, have reported loss reserves equal to at least 25% of loans to the "Baker 33" listed countries.


Tables 1 and 2 present brief highlights of other provisions of OBRA 89 of which practitioners may wish to take note.


It is difficult to get your arms around OBRA 89 because there is no clear theme other than revenue raising. Consequently, tax reform has been put on the back burner, and practitioners must review the new legislation in its entirety, to find out which portions are of greatest interest. omega

Appreciation is expressed to my former tax partners at KPMG Peat Marwick for providing material in the preparation of this article.

Walter F. O'Connor, MBA, PhD, CPA, is a Professor of taxation and Accounting and Director of the Masters in Taxation program at Fordham University Graduate School of Business Administration. He is a member of the AICPA, New York and New Jersey Societies of CPAs, the AAA, and the NAA. Prof. O'Connor is a retired Partner of KPMG Peat Marwick. He is on the Board of Trustees of the United Nations Association of the U.S.A., the Board of Directors of the U.S. Council for International Business, the President's Board of the Asia Society and Vice Chairman of the U.S. Korea Society. He has published articles in international publications and lectured to international groups on accounting, taxation, international business, and telecommunications.

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