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and to sulfur at a 23 percent rate. Percentage depletion for coal at 5 percent was established on the floor of the Senate by the adoption of an amendment offered by Senator William Henry King of Utah after a very few minutes of debate. The 5 percent level was later ratified by the conference committee dealing with the 1932 Act and adopted by both houses of the Congress.

For nearly two decades following the enactment of the Revenue Act of 1932, the concept of percentage depletion was discussed and debated, with the result generally being the extension of percentage depletion to cover other depletable natural resources. Percentage depletion was a particularly volatile subject with respect to oil and gas. The 5 percent afforded coal mine operators was generally not challenged except when a proposal was made to repeal percentage depletion generally.

The next significant Congressional action with respect to percentage depletion for coal came with the consideration of the Revenue Act of 1951. The House Ways and Means Committee raised the percentage depletion allowance for coal from 5 percent to 10 percent, an action the Senate Finance Committee would later ratify. The report of the House Ways and Means Committee noted that the action would have been taken the year before had not revenue constraints made adoption of the provisions impractical at the time. While considerable time on the Senate floor was dedicated to opposing provisions of the 1951 bill which liberalized the tax treatment of natural resources, those efforts met with little support. Again, most of the attention focused on percentage depletion for oil and gas, although the question was raised as to why a 100 percent increase in the depletion allowance for coal was appropriate. The responses were couched

in terms of national defense, and the necessity to provide natural resource producers the means by which they could replace their reserves, and earn a fair return on their investment in light of the risks involved.

In 1954, the Congress reviewed and recodified the federal income tax laws. Percentage depletion was largely unchanged by the recodification with percentage depletion for coal remaining at the 10 percent level established three years earlier. Over the ensuing years, there were a number of small modifications to the percentage depletion statute as it applied to coal. During this time, most of the attention was focused on the oil and gas industry with the Tax Reduction Act of 1975 providing for the repeal of percentage depletion for integrated oil and gas companies. However, in 1982, the passage of the Tax Equity Fiscal Responsibility Act (TEFRA) reduced the benefits from percentage depletion available to coal and iron ore producers by 15 percent once depletion exceeded the taxpayer's adjusted basis in the property. Efforts to increase the cutback in 1984 failed when an amendment on the Senate floor repealed the increase previously approved by the Senate Finance Committee.

2. Capital Gains for Royalties

Current Law. The owner of coal reserves in place is entitled to Section 1231 (generally capital gains) rates with respect to royalty income received from qualified leases. To qualify, the lessor must retain an economic interest in the reserves transferred and must have held the property for more than six months at the date the coal is mined. The lessor cannot be a co-adventurer, partner or principal in the mining of the transferred coal. Percentage depletion is not allowed on royalties qualifying for the capital gains treatment.

Administration Proposals. The Administration proposes to repeal the special tax treatment for coal royalty income effective January 1, 1989. Between January 1, 1986 and January 1, 1989 capital gains treatment would be phased out. For corporations, capital gains, currently taxed at 28 percent, would be

taxed at a 30 percent rate in 1986, 31 percent in 1987, and 32 percent in 1988. For individuals, the exclusion rate on capital gains from coal royalties, currently at 60 percent, would be reduced to 30 percent in 1986, 20 percent in 1987, and 10 percent in 1988.

Legislative History. Prior to 1951, coal royalty payments were taxed as ordinary income. In 1951, the House Ways and Means Committee acted to provide "tax relief for the recipients of coal royalties," by applying capital gains treatment to coal royalty payments. The Ways and Means Committee also provided that royalty payments receiving the capital gains treament would not be entitled to percentage depletion. In considering the the Senate Finance Committee made a number of technical changes, adopting the substance of the "capital gains" provision.

legislation,

As part of the Deficit Reduction Act of 1984, the Senate passed, and the conference committee approved an amendment to the coal royalty capital gains provision providing that the capital gains treatment would not extend to a related party royalty recipient who controlled the taxpayer actually disposing of the coal. It was the intent of the Finance Committee in adopting the provision that the tax treatment of coal producers should be the same whether they operate through a single entity or a combination of related parties.

3. Reclamation and Closing Costs

Current Law. Generally, accrual basis taxpayers are not allowed a deduction for expenses until there has been economic performance (i.e., the work has been performed). Cash basis taxpayers get no deduction until costs have been paid. However, current law allows cash basis taxpayers to elect to deduct qualified reclamation and closing costs before the actual

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reclamation or closing activity. Qualified costs include those incurred after July 18, 1984, which are required by applicable federal or state law. The taxpayer may revoke the election at any time.

This revocation cannot be changed without consent from

the Commissioner.

The amount of the reclamation deduction is the cost allocable to the portion of the property mined during the tax year. The amount of qualified closing deduction is the cost allocable to reserves produced during the tax year. The reclamation cost deduction is based on a portion of the property that has been mined while the closing cost deduction is computed on a units of production basis. The deduction for both is limited to the balance in the reserve accounts as discussed below.

Taxpayers are required to establish a separate reclamation reserve account and a separate closing cost reserve account for each property. The opening balance of each account is zero. Each account is increased by the reclamation or closing cost deduction and an imputed interest amount and decreased by actual cash payments. The imputed interested is calculated at 70 percent of the Federal short-term rate for 1984 through 1985, 85 percent of the Federal short-term rate for 1986 and 100 percent of the Federal short-term rate for 1987 and future years. This interest is compounded semiannually.

If the balance in the reserve account at the end of the tax year (including the imputed interest) exceeds the current cost that would have to be paid if reclamation or mine closing were done currently, the excess must be included in income. Taxpayers are also required to recognize income for any reserve balance remaining in the accounts (a) after reclamation and closing activities have been completed, (b) upon disposition of the property, or (c) upon revocation of the election to expense the reclamation and closing costs.

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If actual cash payments made during the tax year exceed the year-end balance in the reserve account (before reduction for the cash payments), such excess is allowed as a current year deduc

tion.

Administration Proposals. Under the Administration proposals, the special rules for reclamation and closing cost deductions would be repealed for mining and production activity occurring on or after January 1, 1986. Such costs would generally be deductible only when the sites are closed or the land is reclaimed.

History. Before enactment of the Deficit Reduction Act of 1984, accrual basis taxpayers could deduct expenses, provided two prerequisites were met. First, all events must have occurred which determine the fact of the liability; and second, the amount of the liability must be determined with reasonable accuracy. In the case of mining reclamation and closing costs, the Internal Revenue Service had taken the position that the liability was not established and the amount was not determinable until the actual reclamation and closing activity had occurred. However, several court decisions supported the position that an annual accrual of mining reclamation and closing costs was deductible for an accrual basis taxpayer. In Ohio River Collieries Co. V. Commissioner (77 T.C. 1369 (1981)), the Tax Court found that mining of the land was the event that established the fact of the liability. This case did not address the issue of determining the amount of the liability. In other cases, the courts had held that the amount could be established by use of reasonable estimates.

The Deficit Reduction Act of 1984 changed the previous law test for determining the timing of deductions for accrual basis taxpayers, providing that accrued expenses would be deductible