PAGENO="0001" FEDERAL ESTATE AND GIFT TAXES 7~~O3~?O& PUBLIC HEARINGS AND PANEL DISCUSSIONS oim T~~3 COMMITTEE ON WAYS AND MEANS HOUSE OF REPRESENTATIVES NINETY~FOURTH CONGRESS S1~COND SESSION ON ~ OENHRAL SUB~FECT OF FEDERAL ESTATE AND GIFT TAXES MARCH 15, 16, 17, 18, 19, 22, ~ND 23, ~976 PART1OF2 March 15, 16, and 17, 1976 d for the use of the Committee on Ways and Means `~2~9~C) U.S. GOVERNMENT PRINTING OFFICE 68-872 WASHINGTON: 1976 PAGENO="0002" COMMITTEE ON WA~S AND MEANS WILBUR J~. MILLS, Arkansas JAMES A. BIXRKE, Massachusetts DAN ROSTE~KOWSKI, Illinois PHIL M. LAND]ITJM, Georg1~ CHARLES A. VANIIC, Ohio OMAR BURL~SON, Texas JAMES C. CORMAN, ~Calffothiá WILLIAM J. GREEN, Pennsylvaiiia SAM M. GIBBONS, Florida JOE D. WAGGONNEI~, JL, Lcvuislana JOSEPH E. KARTH, Miiinesota OTIS G. PIKE, New York RICHARD F. VANDER VEEN, Mic14gan J. J. PICKLE, Texas HENRY HELSTOSKI, New Jersey CHARLES B. RANGEL, New York WILLIAM R. COTTER, Connecticut FORTNEY H. (PETE) STARK, California JAMES R. JONES, Oklahoma ANDY JACOBS, Ja., Indiana ABNER J. MIKVA, Illinois MARTHA KEYS, Kansas JOSEPH L. FISHER, Virginia HAROLD FORD, Tennessee JOHN M. MARnN, Jr., Oh~ef Oounsei J. P. B~ic~n*, A~iisfa~t rJh~ef Oou*sei JoHN K. MEAos~sa, MiNority Counsel AL ULL~AN, Qr~goi~, ChaArtnan *HERMA~ T~ SiDE EEl EX4J, Pennsylvania BARBER B. CONABLE, Ja,, New York JOHN J. IflJNCAN, Tennessee DONALfl D. CL4NCY, 0140 BILL ARCHEI~, Texas GUY V~NDER JAGT, Michigan WILLIAM A. SPEIGER, Wisconsin PHILIP M. CRANE, Illinois BILL FRENZEL, Minnesota JAMES G. MARTIN, North Caj~olina ~L A.~ (SKIP) I3AFALIS, Florida WILLIAM M. I~I~TCIIUM, California (11) PAGENO="0003" CONT1~NTS [Part 1 ~ pp. 1-854, Part 2: pp. 855-1~?50] Press release of Friday, February 20, 1976, `añnouncit~g panel discussioiis and public hearings on the general subject of Federal estftte and gift taxes_ ~_ - WITNESSES Department of the Treasury: Charles M. Walker, Assistant Secretary far Tax ?pll~y, arid Dale Collinson, legislative eaurisal - -, .~_ -.... - - 1175 Abdnor, Hon. James, a l~epresenta~4ve in Corigress from ~be State of South Dakota * Abouresk, Hon. Jiuries~ a U.$. $enator from the State of south lDakota.... - 860 Ad 11o~Agricult~r~i Tax Commibtee, Don Waodward 11 American Agr~-Women:. Jo Ann Vogel Doris Brandi 79~ Audrey Sickinger .. - - 792 American. Assoc~atiori of Presidents of ~adopendent Colleges a~ul Universities: S Conrad Teitell. -~ 1090 John E. Horner~, s--- American Bankers Association, Thomas A. Meife, J. H. Butala, Jr and Paul F. J3utler. Anierican Bar Association Committee on Estate and Gift Taxes, Prof. Edward C. Haibach~ Jr 1405 American College of Probate Counsel, William P. Cantwell Americ~ Council on Education, ?i~of. Jufta~i Levi American Farm Buroau Federation~, Milan Qraat American Forestry Association, William B. Towejl 560 American Iristitute of Certifl~d Public Accountants, William C. Pe~1e1ç, Arthur llo4Tmain, a,nd Joel F~r~ - - - 309 American National Cattiemen's~sooi~tjon: B. II. Si~oemaker, Jr - - 587 Samuel P. Guyton Anderson, if ~n. John ~3., a presentative iu~ Caqgress from the State of Illinois ~63 Andrews, lion, Mark, a flep$senti~,Uye in Cionigeess from the St~te oil North Dakota Associated Milk Prod~cers ~id-Sta,te reg~o) Women $ Au~dflary, Barbara Brookshire S ~ 17 Association for Adva~oad Lif~Vnder~rttin~g, Qeral&~1. Sherman Baldus, Hon~ Alvin, a Representative in Congress from the State of Wisconsin ~79 Bassett~ Dr. David R., National ~ouncilfor a Wor I~e~~e ~X'a~ 4~,.. - 1158 Baucus, Hon. Max, a ~epresentative in Can~res~ from the State of Montana - * * 867 Baum~n, Hon. Robert E., a Repreaentathte in ~ongres~ from the S~Me of Maryland ~Beall, ~Ión. J. Glenn, Jr. a~TJ~S. Sen~tothom the Stat~ of Marylan~,.~~,. - 44~ Bedell, Hon. Berkiey, a ~epres~nt~t~ein Co~ngress from tb.e~tate of Iowa.. Bell, Aliscn. Ci., Was1iin~ton, 13.C ~ ~..-.._ 922 Bock, Alan W., Libertarian Advocate - ~. - .. 809 Brandi, Doris, American Agri4~omen and Wisconsin Women fo~ 4ri~ culture S - ~ 791 Brandqn, Robert M., Public Citizen ~ Research Group a~i (inn) S PAGENO="0004" lv Page ~Brannon, Gerard M., Georgetown University 616 i3rookshire, Barbara, Associated Milk Producers (mid-State region) Women's Auxiliary l3rownlie, William D., Boston, Mass 780 Bump, Wilson, Monmouth, Oreg .. 927 Butala, J. H., Jr., American Bankers Association, 48 Butler, Paul F., American Bankers Association 48 Byron, Hon. Goodloe E., a Representative in Congress from the State of Maryland 662 Caritwell, William P., American College of Probate Counsel 691 ~Mrpenter, L. C., Midcontinent Farmers Association 6 Casner, Prof A James, Harvard University (invited panelist) 1333 Cathey, 11. A., Charlotte, N.C_ 945 Chamber of Commerce of the United States, Walker Winter, B,obertR, Statham, and Donald McDonald 334 Chauncey, Rev. George A., Interreligious Task Force on U.S. Food Policy.... 828 Chicago Bar Association Committee on Federal Taxation, Hugo J. Melvoin 684 Clagett, Brice M., Maryland Historical Trust 974 Coalition for the Public Good, Donald A. Tollefson 946 Connecticut Child and Family Services, Roger J. Sullivan 942 Council for Financial Aid to Education, Raymond C. Johnson 1129 Council of Small Independent Business Associations, Edward H. Pender- gast, Jr 386 Council on Foundations, Inc., Robert F. Goheen 1134 Covey, Richard, Carter, Ledyard and Milburri, New York, N.Y. (invited panelist) 1210 Criswell, W. B., Plains Cotton Growers Association 23 Cunningham, T. A., Independent Cattlemen's Association of Texas 621 Davidson, John C., the Tax Council 520 Dodge, Joseph M., II, University of Detroit School of Law 750 Dorgan, Byron L., North DakotaState Tax Department 836 Emery, Hon. David F., a Representative in (1ongress from the State of Maine 879 Esch, Hon, Marvin L., a Representative in Congress from the State of Michigan 869 Fithian, Hon. Floyd J., a Representative in Congress from the State of Indiana 883 Florida Cattlemen's Association, Airic Pottberg. 624 * Forest Industries Committee on Timber Valuation and Taxation: Bradford S. Weliman - 550 J. Gordon Powell 558 Forster, Joel, American Institute of Certified Public Accountants 309 Franz, Delton, National Council for a World Peace Tax Fund 115~3 Fraser Arvonne, Women's Equity Action League 902 Furber, Jacqueline J., Wolcott, N.Y - 825 Geiss, Albert B., International Association of Ice Cream Manufacturers and Milk Industry Foundation 20 Goheen Robert F., Council on Foundations, Inc 1134 Graetz, Prof. Michael, University of Virginia (invited panelist) 1233 Grant, Allan, `American Farm Bureau Federation 8 Grant, John F.,Printing Industries of America 516 Grassley, Hon. Charles B., a Representative in Congress from the State of Iowa 676 Gray, Virginia M., Washington, D.C 920 Guyton, Samuel P., National Livestock Tax Committee, American National Cattlemen's Association, National Livestock Feeders Associa- tion and National Wool Growers Association 588 Ilalbach, Prof. Edward C., Jr., American Bar Association Committee on Estate and Gift Taxes, and University of California (invited panelist).~. 1408 Hall, Hon, Tim L., a Representative in Congress from the State of Illinois.. 885 Hance, `Young D., Maryland Department of Agriculture 850 Harkin, Hon. Tom, a Representative in Congress from the State of Iowa.. 886 Harrison, B. Powell, Jr., Piedmont, Va., Environmental Council 845 Haskell Hon. Floyd K., a U.S. Senator from the State of Colorado 452 Heyman, Alice, Natjonal~Women's Political Caucus 917 Iiildreth, Horace, Maine Audubon Society ..* 413 Hoffman, Arthur, American Institute of Certified Public Accountants...... 309 PAGENO="0005" Vi Page Etorner, John E., American Asso~iatlozi of Presidents `of independent colleges and~LJniversities 1126 Hubenak, Hon. Joseph, National Conference of State Legislatures 774 Ibach, Paul B., Shriners Hospitals for Crippled Cbildren_ 939 Independent Cattlemen's Association of Texas, T. A. Cunningham 621 International Association, of Ice Cream Manufacturers, Albert B. Geiss.. - 20 I~nterreligious Task Force on U.S. Food Policy, rtev. George A. Chauncey~ - 828 Jantscher, Dr. Gerald R., Brookings Institution, Washington, D.C. (invited panelist) 1419 Johnson, Raymond C., Council for Financial Aid to Education 1129 Jones, B. H. (Bill), National Livestock Feeders Association 587 Jones, Hon. Ed, a Representative in Congress from the State of Tennessee.... 967 Lane, Laura, Philadelphia, Pa 813 Lehrfeld, William J., Shriners Hospitals for Crippled Children 93~ Levi, PrOf. Julian, American Council on Education~ 1003 Lewis, James, Paul, Weiss, Rif kind, Wharton & GarrIson, New York, N.Y. (invited panelist) 140~ Libertarian Advocate, Alan W. Bock 809 Mahon, Hon. George H., a Representative in Congress from the State of Texas 3 Maine Audubon Society, Horace Hildretk. ~. 413 Maryland Farmers Produce Associ~tion, Bernard Schwartz 1002' Maryland Historical Trust, Brice M. Clagett 974 Maryland, State of, Department of Agriculture Young D. Hance . 85~ Maryland Workforce on Preservation of Farm. f~and, Gene Mullinix 852 Mathias Hon. Charles MeC., Jr., a U.S. Senator from the State of Mary- land - 44~ Mayberry, W. Eugene, Mayo Foundation 1127 Mayo Foundation, W. Eugene Mayberry 1127 McOamant, William C. National Association of Wholesaler-Distributors.... 39~ McClhiton, Clark C., ~ationa1 Limestone Institute. 56& McDonald, Donald: Chamber of Commerce of the United States 334 Montgomery, McCracken, ~Walker & Rhoads, Philadelphia, Pa. (in-. vitect panelist) 1274 McEwen Hon. Robert C., a Representative in Congress from the State of' New fork - 656 McGinty, Edward Tampa, Fla 722 McKevitt, James B., National ,~?ederation of Independent Business 382 McRee, Johnson, Jr., National Association of Manufacturers 458 McSorley, Fr. Richard T., S.J, National Council. for a World Peace Tax Fund 1145 Melfe, Thomas A., American l3ankers Association 48 Melvoin, Hugo J., Chicago Bar Association Committee on Federal Taxa- tion 684 Midcontinent Farmers Association, L. C. Carpenter 6 Milk Industry Foundation, Albert E. Geiss 20 Moore, `Hon. `W. Henson, a Representative in Congress from the State of Louisiana 898 Moran,' Prof. Gerald P., University `of Toledo, College of Law 741 Mullinix, Gene, Maryland Workfor~O on Preservation of Farr~i Land.._ - - 852 Nathan, Ronald, National Women's Political Caucus 917 Nash, John, National Automobile Debl~s Association .._._.._ 394 Nstionál Association of Manufacti~~e~s, Johnson McRee, Jr., and Mar- shall L. Zissman 458 National A~sociation of Wheat Growers, Don Woodward -- 11 National Association of Wholesaler-Distributors, William C. McCamant.. 39~ National Automobile `Dealers Association, JOhn Nash and Kevin Tighe__ 394 National Conference of State Legislatures, Hon. Joseph Hubenak 774' National Council for a World Peace Tax Fund:' Fr. Richard T. McSorley, S.J 1l4E~ Dr. David R. Bassett 1158 Ralph E. Sxneltzer 1157 Delton Franz , h15~ Ed Pearson..~~ - h15~ National Fañners Union: ` ` . David M. Weiman 970 Beulah Torgerson 972 National Federation of Independent Business, James D. McKevitt - 382 PAGENO="0006" VT National Limestone Institute: Page Richard P. Rechter 563 Clark C. McClinton 566 iNational Livestock Feeders Association: Samuel P. Ouyton 588 B. H. (Bill) Jones - 587 National Livestock ~ax Committee: Samuel P. Guyton 588 E. H. ~hoemaker, Jr. 58~ National Realty Committee, Albert A. Walsh 343 National Small Business Association, Milton D. Stewart _.. -- -- 384 National Women's Political Caucus, Alice Heyman and Ronald Nathan~.. 917 National Wool Growers Association: Samuel P. Guyton 588 James L. Powell 587 Nebraska State Legislature, Hon. Dennis Rasmussen . 841 Needham, James J., New York Stock Exchange, Inc 46 Nelson, Hon. Gaylord, a U.S. Senator from the State of Wisconsin 417 New York Stock Exchange, Inc., James J. Needham 465 North Dakota, State of, Tax Department, Byron L. Dorgan 836 Packwood, Hon. Bob, a U.S. Senator from the State of Oregon 440 Pearson, Ed, National Council for a World Peace Tax Fund 1159 Pendergast, Edward H., Jr., Council of Small Independent Business Associations 386 Penick, William C. American Institute of Certifiçd Public Accountants_ 309 Piedmont, Va., Environmental Council, B. Powell Harrison, Sr 845 Pietz, William, Public Citizen Tax Reform Research Group 351 Plains Cotton Growers Association, W. B. Criswell 23 Pottberg, Alric, Florida Cattlemen's Association - 624 Powell, J. Gordon, Forest Industries Committee on Timber Valuation and Taxation 558 Powell, James L., National Wool Growers Association 587 Printing Industries of America, Frank B. Reilly and John F. Grant 510 Public Citizen Tax Reform Research Group, Robert M. Brandon and William Pietz 351 Rafert, Helen, Gresham, Nebr 800 Railsback, Hon. Thomas, a Representative in Congress from the State of Illinois~ - 659 Rasmussen, Hon. Dennis, Nebraska State Legislature 841 Recbter, Richard P., National Limestone Institute 563 Reese, Thomas J., Taxation With Representation 472 Reilly, Frank B., Printing Industries of America 516 Reister, Raymond, Minneapolis, Minn~ - 777 Royal, Mrs. Lloyd, Springfield, Nebr 793 ~Schwartz, Bernard, Farmers Produce Association of Maryland 1002 sherman, Gerald H. Association for Advanced Life Underwriting 535 Shoemaker, E. H., Jr., National Livestock Tax Committee and American National Cattlemen'wAssociation 587 Shoup, Prof. Carl, Co1u~bia I.Tniversity (invited panelist) 1227 Shriners Hospitals for Crippled Children, C. Victor Thornton, Paul E. Ibach, and William J. Lehrfeld 939 Sickinger, Audrey, American Agri-Women and Wisconsin Women for Agriculture 792 Sisk, Hon. B. F., a Representative in Congress from the State of Calif ornia~ 855 Smeltzer, Ralph E., National Council for a World Peace Tax Fund 1157 Smith, Donald 0., Boston, Mass 783 Smith, Prof. James D., Pennsylvania State University (invited panelist) - 1309 Smith Hon. Virginia, a Representative in Congress from the State of Nebraska 680 Soloway, Belle, Women's Lobby, Inc 915 Statham, Robert R., Chamber of Commerce of the United States 334 Stewart, Milton D., National Small Business Association 384 Sullivan, Roger J. Connecticut Child and Family Services 942 Sutherland, William A., Washington, D.C 721 (The) Tax Council, John C. Davidson 520 Taxation With Representation, Thomas 3. Reese 472 PAGENO="0007" VII Taylor, ~Ion. Gene, a Represent~itive in Congress from the State of 1~g. Missouri 863 `I~eite1l, Conrad, A~nerioa~ Association of Presidents of Indepeadent Oolle~e~s and Universities - -- -` - ---- - * - - -~ - -~ - 1000 Thornton, C. Victor. Shriners Bospital~fo~ Crippled Childr~i& _~~__ - - 9~9 Tighe, Keviji~ National Automobile Dealet~ Association 304 Tollefson, Donald A., Coalition for the Public ~ 946 Torgerso~,~ ~euIah, National Farmers Union ~.. 972 Tow~ll, Williajn E~, American Forestry Association 560 Tree~i, lion, David C,, a Representative in~ Congress f±oxn the State of Loulsinna - ~. 876 Vogel, Jo Ann, American Agri-Women and Wisconsin Women for Agri- cu1ture~. 789 Walsh, Albert A, National Realty Committee 343 Wampler, lion. *iiiam C., a Representative in Congress front the State of Virginia Weliman, Bradford S., Forest Industries Committee on Timber Vniuatlon and Taxation - 550 Weiman, David M., National Farmers Union~,: 970 Winter, Walker, Chamber of Commerce of the United States ~_ _~ 334 Wisconsin Women for Agriculture: Jo Ann Vogel ~, 759 Doris Brand! - ,, 791 Audrey Sickinger - - 792 Women's Equity Action. League, ArvQnne Fraser 902 Women's Lobby, Inc., Belle Soloway 91~ W~odward~ Don, National Association of Wheat Growers and Ad Hoc Agricultural Tax Committee - 11 World Peace Tax Fund. (&e National Council for a Wor~d Peace Tax Fund.) Zissntan, Marshall L., NatiQual Association of Manufacttu'ers 458 MATERIAL SUBMITTED FOR THE RETORD Abzug, Hon. Bella S., a Representative in Congress from the State of NeW Yørk statement 14$5 Aging S~ervices Center of Sioux Falls, S. Dak., Larry Oppoid, letter -- 1724 Akerson, 3. A., Claremont S. Dak., letter 1732 Alexander, Hon. Bill, a i~tepresezitative in Congress. from the State of Arkansas, statement * 1482 Allen, Wayne, and Laura, I~adoiça, S. IDak., letter.~.. ~..,,... ~. - ~ 1732 Allison, Janet B., Washington Women for the Survival of Agricnlture~ letter _~ 1721 American Association of ~una-Lising Counsel, fnc~, John J. Schwartz, statement~~ -, 1519 American: Association of Retired ?ersous, National Retiree Teachers As- sociatiói st~toment ~----~ - * 1517 Arnerics~n bar AssoCiation, S~~cial Committee on 1tetirom'e~t Benefits Legislation, Bruce Griswold letter~, - - - 1507 American Council for Capital ~Formatiori, Charis J~. Walker, etatentent.. 1507 American Fe4eration of Labor and Congress of Industrial Org~zs~tlons, Andrew J.. Biemiller, statemenL.. - ISGS American Horse Council, Inc., statement 1548 American hospital As elation statement 1511 American Legion, Cbarl~es E~. 1V~attingly, statement 1512 American Lifi~ Insuranc~Association, statement I~513 Anderson, Ra1~h, La Bolt~, S. Dak~, letter 1733' Ant4nk, 3. R., Salvation Army, letter .. 1534 A~tioch College, Morris T. 1~eeton letter...~_ * -~ - * -- .~ 1570 Armstrong, John Junior, ICansas 1~arm l3ureau, letter `and statemenL. - - - 1562 AuCoin, lion. Les, a Representative in Congress from ~ho State of Oregon, statement .,~ __,~. ~ iso~ Automotive Service Industry Association, ~ichard ~. Qooper, Jr~letter..,_ 1548 Baer, Stuart M., VentuoT City, N.J., statement..,. - ~ ~ - 1714 Baye & Sons ~dmund Baye, ?hilip, B'. i~ak., letter ~ 1733 Eannon, Joan,~ Council on ~ationaI,Prtorities and 1~cesources, sthteznent,.,. 1544 Barnes, Garth and Lauretta, Cody, ~ebr., lei~tei'_ 1714 PAGENO="0008" VIII Bausch, Mrs. Richard (Helen), United Farm Wives of America, Inc., Page Kansas chapter, statement 1709 Beach, Robert W, and Doris L., Rapid City, S. Dak., letter 1733 Beard, Hon. Robin L., Jr., a Representative in Congress from the State of Tennessee, statement 1489 Beck, Mr. and Mrs. Clyde V., Winfred, S. Dak., letter 1733 Beier, Mr. and Mrs. Ben, Lake Preston, S. Dak., letter 1734 Berea College, Willis D. Weatherford, letter forwarded by Congressman Romano L. Mazzoli 1571 Berg, Royal and Grace, Baltic, S. Dak., letter 1734 Biemiller, Andrew J., American Federation of Labor and Congress of Industrial Organizations, statement 1508 Biester, Edward G., Jr., a Representative in Congress from the State of Pennsylvania, statement 1470 Bittker, Prof. Boris I., Yale Law School, letter and enclosures 1585 Boling, Edward J., University of Tennessee, statement 1582 Borah, Carmon, Huron, S. Dak., letter 1734 Boskin, Prof. Michael J., Stanford University, letter and enclosure 1604 Boss, Donald R., Cedar Falls, Iowa, letter 1708 Bowen, Hon. David R., a Representative in Congress from the State of Mississippi, statement 1490 Branch Robert, Paragould, Ark., letter 1703 Braunschweig, Lucille E., Rubicon, Wis., statement 1722 Brown, Hon. Clarence J., a Representative in Congress from the State of Ohio, statement 1476 Brown, Edwin W., Canistota, S. Dak., letter 1734 Bylander, Daniel, Beresford, S. Dak., letter 1735 Carter, Ida Custer, S. Dak., letter 1735 Chesapeake Growers, mc,, Leon J. LaChance (and 20 others) letter 1711 Chess, Mary Beth, Women for the Survival of Agriculture, letter 1715 Christensen Dale, Beresford, S. Dak., letter 1735 Christensen, Marlow Beresford, S. Dak. letter 1735 Christensen, Mrs. Ralph, Beresford, S. liak., letter 1735 Church of the Brethren, Dean M. Miller, statement 1522 Clarke, Prof. Jack, University of Alabama School of Law, letter and en- closure 1639 Clausen, Hon. Don IL, a Representative in Congress from the State of California, statement 1472 Clearwater Estate Planning Council, James 0. McMain, letter 1673 Coale, Jack St. John's Hospital of Springfield Ill., letter . 1707 Coan, Carl A. S. Jr., National Association of home Builders, letter 1541 Coburn, A. A. ñeadwood, S. Dak., letter 1731 Committee of ~Banking Institutions on Taxation, John K. Daly, statement. 1515 Concordia Teachers College, W. Th. Janzow, letter 1572 Cooper, Richard F., Jr., Automotive Service Industry Association, letter.... 1543 Council of Jewish Federations and Welfare Funds, statement 1529 Council on National Priorities, and Resources, Joan Bannon, statement.. - 1544 Cram, Wayne L., Maitland, Fin., statement 1703 Daly, John K., Committee of Banking Institutions on Taxation, statement 1515 David, Doris P. Orlando, Fla., letter 1704 Davis, Charles *. National Association of Brick Distributors, statement_ - 1516 Dean, Ford L., 1~oard of County Commissioners of St. Mary's County, Md., letter 1710 Deering, Darlene K., National Organization for Women, Vermillion, S. Dak., chapter, letter 1725 Deibert's, Inc., R. R. Deibert, Eureka, S. Dak., letter 1736 de la Garza, E Kika, a Representative in Congress from the State of Texas, statement 1477 Delit, Steven N. New York, N.Y., letter and enclosure 1673 Delta Council B. F. Smith, letter 1570 Dorufelci, Dennis D. University of Wisconsin-Extension, letter 1573 Eggers, Maxine E., and William D. Sioux Falls, S. Dak., letter 1736 Engelgau, Florence Sioux Falls, S. ~Dak., letter 1736 Enlund, E. Stanley, National Board of Young Men's Christian Associa- tions, statement 1532 Eshleman lion. Edwin D., a Representative in Congress from the State of Pennsyi~vania, statement 1480 Fabisch, Carol, Beaver Dam, Wis., statement 1722 PAGENO="0009" rx Page Farmers & Merchants SU~ts Banl~ çs IDak) R W Habber~tad~ Jétter~. - 1725 Farmers State Bank öf r~tth S: IDak., F1~a~ic$rs M~ N~~l~ind ~ 1~T2~ Farmers State Bank p1' Kranzb~rg, ~ Dak., Jerome J. Turbai~, ~ 1726 F~st Dakota N~t1oli~l Bank, David t). ~iross,l~tter ,. 1726 First National Bank of Aberdeen (S~ Dak.), Milbank Bran~h, Meriir~ L. Stocking, letter_ 1726 First National Bank of the Black hills, S~ Dak., Willard ?utnmel, l~tte~__ *1727 First National Bank of ?hilip, S. ~Dak;, Grégor A. Weber, lbtter - ~. 1727 ~irst State Bank of Armour, S. Dak. R. L, Plowman, letter - 1728 First State Bank of McLaughlin, ~. f~ak., L~rry~ ID. Petth~o!~i, letter 1728 Fraser, Mr. and Mrs. Dales Plankintoü, S. Dak., letter. - . 1737 Fra~er, Hon. Donald M., a Re~r~se~itative in Congress &orn tile State~ of Minnesota, statement - 1473 Gamache, Kay `~oppenisli Wa~h~ letter 1720 Qarry, Harry, New York 1~arm Bureau, statemenL - - - - - 1~64 Garry, R. H., Security Bank & Trust Co. of Webster, S. Dak4, letter 1729 Gertonson Arnold A., D.V.M., Philip, S. Dak., letter 1737 Goering, drlando J., and Violet, Vermillion, S. Dak., letter ~. - -~ - 1737 Goodling, Hon. William F., a Representative it~ Congress. fr!an the State of Pennsylvania, statement ~ ~ 1503 Greenstreet, Elizabeth B., Cooksville MU., letter_. 1711 Gresslin, Mrs.. Louis, Sioux Falls, S. bak., letter_ 1737 Griswold, Bruce, American Bar Association, Special Committee on Retire- ment Benefits Legislation, letter 1507 Gross, David D., First Dakota National Bank, letter 1726 Habberstad, R. W., Farmers & Merchants State Bank, letter ~...... 1725 Rackens, Kathryn (and 13 others), Lazy Loafers Extension Club, letter_.. 1781 .Haebler, Herbert J., iii, Baltimore, MU., letter - 1711 ff~gedorn, Hon. Tom, a flepresentative In congress from the State of Mlnnesota, statement 1491 Rail, Kathryn B., El Paso, Te~., 1et~er 1719 Hanson, ~Mr~ ~and Mrs. Harry; Arth~ir and Judy, Philip, $~ Dsk~, letter~~~ 1738 Hardin, Mary Jane, RapldClt~, S. liak., letter 1738 Harsha, lion. William H., a Representative in Congress from the State of Ohio, statement 1469 Haugo, Erling, Valley National Bank, letter 1730 Haynes R. S., Spink County (S. Dák.) Bank letter~ 1730 Realy, ~Patrlck B. National Milk Producers *ederation, ~ 1557 Heunrikus, Col. deorge F., Jr., Retired Officers Association, statenient.~..~ 1518 Hofstad, Ralph, Land O'Lakes, Inc., letter .~_~__ 1712 Holloway, Thelma K., Ellicott Clt~r, Md. letter 1711 Horsley, Wayne, and Joan, Curtis, and Rilonda, South Dakota, letter.... 1738 1io~tck, E. A., and Eva D., G~ttysbur~, S. Dak., letter .~.. 1738 Hughes, lion. William J., a Representative in congress from the State of New Jersey, statement . ~5Q5 Hull, 0. M., Yakima, Wash, letter 1721 Hull, C. T., Spearfish, S. Dak., letter - 1739 Hull, Hubert G., Yakima Wash. letter 1721 Humphrey, Hon. Hubert ~fL, a U.S. Senator from the State of Mjnnesota, statement 1447 Hungate, Hon. William L., a Representative in Congress from the State of Missouri statement ~. 1475 Inglis, Burton F. Clifton Springs, N.Y., lettet 1716 James, Robert, 1\~. Sioux Falls, S. Dak., letter 17~0 Janzow, W. Tb., doncordia Teachers College, letter 1571 J~rboe, J. Patrick, M.D., B,oa~d of County Commissioners of St. Mary's County, Md., letter 1710 Jassmann, Art, Sr., and Ruth M., Pierre, S. Dak., letter 1739 Jensen, Lylla M., and Harold E., Madison, S. Dak,, lettef 173.9 Jensen, Robert L., Seneca Castle, N. Y., letter 1717 Johnson, Donald J., Centervllle, S. Dak., letter 1740 Johnson, Hon. Harold T. (Bias), a Representative in ck~ngress fro in he State of California, statement 1467 Jones, Eileen, Sioux Falls, S. Dak., letter 1740 Kaiser, Frederick, Winner, S~ Dak., letter - ~.- - 1740 Katlsas chapter, United Farm Wives of America, Inc., Mrs Richard (Helen) Bausch, statement 1709 PAGENO="0010" x Page Kansas Farm Bureau, John Junior Armstrong, letter and statement 1562 Kasten, Hon. Robert W., a Representative in Congress from the State of Wisconsin, statement 1493 Kazen, Hon. Abraham, Jr., a Representative in Congress from the State of Texas, statement - 1481 Keeton, Morris T., Antioch College, letter 1571 Kelley, Donald H., North Platte, Nebr., letter and enclosure 1675 Kennedy, Hon. Edward M., a U.S. Senator from the State of Massachusetts statement 1451 King, Mr. and Mrs. James, Stephan, S. Dak., letter 1740 Kludt, Debora K., Alpena, S. Dak., letter 1740 Knox, Mr. and Mrs. Albert H., BaltAc, S. Dak., letter 1741 Kosson, Aubrey, Hato Rey P. R. letter 1718 Krasicky, Eugene, United ~tates Oatholic Conference, statement 1535 Kroetch, Arthur A., Little Scotchman Industries, letter 1731 Krueger, Kim J., Wyoming Stock Growers Association, letter 1569 Kyser, Mrs. John S., Natchitoches, La., letters 1709 LaChance, Leon J., (and 20 others), Chesapeake Growers, Inc., letter. -- 1711 Lampert, J. A., Rapid City, S. Dak., letter 1741 Land O'Lakes, Inc., Ralph Hofstad, letter 1712 Larson, Allen R., East Haven, Conn., letter and enclosure 1645 Lawson, W. D., III, National Cotton Council of America, letter 1554 Lazy Loafers Extension Club, Kathryn Hackens (and 13 others), letter_ - - - 1731 L. B. Benefits, Inc., L. E. Lee Lohman, statement 1704 Lentz, Hover T., Denver, Cob., letter 1692 Lerdal, Herman, Mitchell (S. Dak.) National Bank, letter 1743 Little Scotchman Industries, Arthur A. Kroetch, letter 1731 Lohman, L. E. Lee, L. B. Benefits, Inc., statement~ 1704 Longley, Hon. James B., Governor, State of Maine, letter - 415 Lucas & Theim, Inc., R. H. Lucas letter 1732 Luther's Livestock Commission M~arket, Debos D. Luther, letter 1715 Maine, State of, Governor James B. Longley, letter 415 Maryland Farm Bureau, Inc., F. Grove Miller, letter 1563 Ma~ting1y, Charles E., American Legion, statement 1512 May, Mr. and Mrs. Edwin C., Midland, S. Dak., letter 1742 Maybury~ Donald L., Waterloo, N.Y., letter 1717 McClory, Hon. Robert, a Representative In Congress from the State of Illinois, statement 1476 McCollister, lIon. John Y., a Representative in Congress from the State of Nebraska, statement 1487 McFarland, Dan, Fredericksburg, Iowa, letter 1708 McGovern, Hon. George, a TJ.S. Senator from the State of South Dakota, statement 1453 McKay, James M., Board of County Commissioners of St. Mary's County, 1710 Md., letter 1723 McKinney, Ella, Waco, Tex., letter 1673 McMain, James 0. Clearwater Estate Planning Council, letter 1673 MeNulty, John K., (University of California, Berkeley) Taxation With Representation, statement 485 Melbern, Robert L., National Association of Farmer Elected Committee- men, statement 1550 Mennonite Cetitral Committee-Peace Section, statement 1529 Mezvinsky, Hon. Edward, a Representative in Congress from the State of Iowa, statement 1498 Michel, Hon. Robert, a Representative in Congress from the State of Illinois, statement 1465 Midman, Mr. and Mrs. Warren, De Smet, S. Dak., letter 1742 Miller, Dean M., Church of the Brethren, statement 1522 Miller, F. Grove, Maryland Farm Bureau, Inc., letter 1563 Miller, Leland H., Houston, Tex., letter 1719 Millison, Larry, Board of County Commissioners of St. Mary's County, Md., letter 1710 Mitchell (S. Dak.) National Bank, Herman Lerdal, letter 1743 Moore, Bruce E., Denver, Cob, letter 1702 Morterison, Sam, McLaughlin, ~. Dak., letter 1743 Muller, Arnulf C., Pawling, N.Y., letter 1716 Naslund, Francys M., Farmers State Bank of Faith, S. Dak., letter 1725 National Association of Brick Distributors, Charles K. Davis, statement~_ 1516 PAGENO="0011" National ~ssociatlon~of U'armer~Elected Committeemen, Z~bertL. Melbern ?age~ statement~. _~ ~ l54SO~ NatjônalA~zq~iationoUi.ome Buillers, Carl ~. ~. Coan,, Jr.,~lebter.. 154 Nationa~ Associatiøn Qf Retail Grocers Q~ the' ~JflIted States~ Thomas F. Wenni~g, statement i~5i National Bankof ~tbDakota, brt~oe J~. Wa1~ør, letter ~ -- ~ational Corn Growers Association, ~ 155& National Cotton Council of America~, W. D.Lawsonlfl,,lotten. ~ 1554 NationalFoodBrQkersAsso~iatiQn,,MarkM!Singer, letter 1555 National Grange, John W. Scott, letter 1556 National ~(Li1k Produoera Fede'rati~n, I~atrioI~B.. I~ea1y,, statement 1557 Natk)nal Organization for Womeu~ Aberdeen (S. flak.) Area,. Royleno S*b~ra'b,, Ietter. 861 Rap11 City, S. flak.9 chapter, Becky Yentman, letter 1724 Si~u~Fafls, S~. flak, chapter, Norine M. ~Yppold, letter 1724 VermiLliQxi,~S. flak., chapter, Darlene K. Deering letter ~ 1725 National. Retired Teachers Ass'oOiation, American Association ot Retired Persons, statemeat. 1517 National Rural El.ectric. Cooperative~ Association, Robert D.. Partzidge~ statement~.,..~.. 1461 Neary, HeleaM., Sioux Falls, S. Dak., letter 174a. Neiber,. Bert D., Pierre, S. flak., letter.... 1744 Nelson,, Duane E., Hills, Miun,, letter.....,.... 1~713, Nelson, Harvey I.,. Siow~ Falls, S. flak., lett~....,.. ~ 1744 Nelson' ~Roger L~, ~1iils,. Minn., letter,.. .._-~ 1713, Ne~ itampebire. TJni,versity of,. QQQperatiVQ E~teusion Service, Silsa 13. iVeeks9 letter forwu~rded by Con~eseman.Nç~rman D?Auiou~s 1573 Ne~v York Farm Bureau, Usrry Garry, sbatement~.+ ~. - ~`.. ~, - 3464 Nolan, `Ron. Richard, ,a Representative~, th~ Congress from the State of `Minnesota, statement.... ... .~ - 897 Oakland Financiab Group, Inc., Von H. Smith, letter 1719 Ohe~r, Ron. Dave, a, Representative in Congress frota the State of Wlseø~- sin. statement..~. ,., 1482 O'Brien, Uo~ George M.,. a, Representative in Congress from the State of Illinois,, statement ~ .......,.,.. ,~ O'Leary,. Mr. and, Mrs. P. C., Yankton, S~ bak.,, letter~.... ~. ~ 1744 Oppold, Larry. Aging Services Center of Sioux Falls, S. flak,. letter 172* Oppold, NQrIin~ M.,. ~ationai Qrganizatiøn fo'r~.Women,, St~ux 4lalle, 8. Dsk~,,. ehapter, ietter...~........._-. `,,~.. ~ 1724 Parlett, John J~., Board of County Commtssioners Qf St ~Xa~y'a County, Md. .letter.~.~.. 1710 Partriàge, Robert, fi,, National Rural Eleotrie Cooperative Ass~cia~tlon, `statement.... , 1561 Peatson, HQn. James B., a U.S. Senator frorn the State of Kansas, state- ment.. .....~_--.. 1449 Peckham~ Thomas E4 and Robert C. Pomeroy, Boston, Mass.,.statemnent.. 1538' Pendleton Everett, Rushville, N.Y., letter.. 1717 Perkins, iha. Carl D.~ a Representative In Congress, from the State of Kentnoky., .ata~teuient 1464 Peterson, Larry D., First State Bank of McLaughlin, S. Dak.~ letter........~ 1728 Pike, Elsi,e and Leonard, Sioux Falls, S. flak., letter 1744 Plowman, ~R. L,, First State Ban1~ of Arzmmur, S. Dak., ~ .,.~. 1728' Foley, W. E~ and Mary B.,. Sioux Falls, 5, flak. letter.. - 1745 Pc~eroy, Robert. C., aa,d~ Thomas E. Peeltii~m, ~oston, Mass., statement.. isaS Pressler, Hon. Larry,.a Representative in Congress from the. State of South Dakota sto~ment............ - ....-.. Pummel, `Willard, First National Bank of the Black Hills, .S~ ,Dak., `ietter_ 1727 Qti&e, Hon.. Albert H., a Representative in Congress from the State o~ Mm- nesota, statement .. - .. . j4~5 Retired Officers Association, CoL George F, H~nnrikus Jr.,~ statement.. - - 1518 Rhodes, Thomas W., end' Barba~a T., Horsebeads, N.'~., letter~.. - ...... -- 1718 Risch, Gus, Brookings, S. flak., .1etter.....,~. ~- +..-,.......- 1745 Ronning~ Mr. and Mrs. Lowell, Deli. Rapids, S. Dak~, letter 1745 Roush, Hon. J~ Edward, a Represemtativ~ in `Congress frQin the ~ of Indiana, statement ~ 1470 Rowe, Mr. and Mrs. Harold, Rapid Clti, S. flak., letter..-......~ 1745 RUbin, Harry J., York Pa., letter . - .. 1694 St. `John's Hospital of ~ptingfleld, Ill., Jaek Coale, letter......_~ 1707' PAGENO="0012" XII St. Mary's County (Md~),' Boards ~f Oóunty Coiith~ii~sioñers, James M. McKay~ John K. Parlett, Ford L. Dean, .J. Patrick Jarboc, M.D.,. and Page Larry Milliso~, letter~. .. 1710 Salvation Army, J. R. Antink, letter - - - L - - 1534 Schallenkamp, Mary Jo, Sioux Falls, S. Oak., letter 1746 Sthwab, Roylene, Aberde~n (S. Oak.)' Area National Organization for Women, detter - - 861 Schwartz, John J., American Association of Fund-Raising Counsel, Inc., statemelit 151~ Scott, John W., National Grange, letter 1556 Sebelius, Hon. Keith G., a Representative in Congress from the State of Kansas, statement 4484 Security Bank & Trust Co. of Webster, S. Dak., R. H. Garry, letter 1729 Shaffer, Louise K., and Lester L., BozElder, S. Oak., letter .._ - 1746 Shriver, Hon. Garner E., a Representative in Congress from the State of Kansas, statement_ - - 1471 Singer, Mark M., National rood Brokers Association, letter _ 1555 Smith, B. F., Delta Council, letter - 1570 Smith, Von R., Oakland Financial Group, Inc., letter 1719 Snethen, Mrs. Maurice, Carter, S. Dak., letter .,...... .~. 1746 Southern Methodist University, James. II. Zumberge, statement~..~ ..~.. - - 1574 Specht, Virginia G., Brookeville, Md. letter -- 1711 `Spencer, Howard W., Broken Bow, N'ebr., letter 1695 Spink County (S. Dak.) Bank, R. 0. Haynes, letter 1730 Steelman, Hon. Alan, a Representative in Congress from the State of Texas, statement 1501 Steiner, Peter K., M.D., and Anna, Sioux Falls, S. Dak., letter 1747 Stephenson, Edward L., Warrenton, Va., statement~ - 1696 Stocking, Merlin L., First National Bank of Aberdeen (S. Oak.), Milbank Branch, letter 1726 Stratton, Hon. Samuel S., a Representative in Congress from the State of New York, statement 1468 Surrey, Stanley S., (Harvard Law School) Taxation With Representation, statement - - 491 Swanson, Margaret, Winner, S. Oak. letter.. ,. - - 1747 Taggart, John Y., New York, N.'~, letter ~.... 1700 Taxation With Representation: John K. McNulty, University of Califbrnia, Berkeley, statement~ - 485 Stanley S. Surrey, Harvard Law School, statement 491 David Westfall, Harvard Law School, `statement 505 Tennessee, University of, Edward J. Boling, statement 1582 Thone, Hon. Charles, a Representative in Congress from the State of Nebraska, statement 1488 Thornton, George R., East Lansing, Mich., letter 1701 Thue, Mr. and Mrs. Deibert, Bryant, S. Oak., letter 1747 Tragesser & Associates, Joseph G. Tragesser, letter 1707 `Turbak, Jerome J., Farmers State Bank of Kranzburg, S. Dak., letter.._ - 1726 United Farm Wives of America, Inc., Kansas chapter, Mrs. Ri~bard (Helen) Bausch, statement 1709 United States Catholic Conference, Eugene Krasicky, statement 1535 Valley National Bank Erling Haugo, letter 1730 Vigorito, Hon. Joseph P., a Representative in Congress from the State of Pennsylvania, statement 1478 Wackerle, A. J., and Shirley J., Sioux Falls, S. Dak., letter 1748 Walker, Bruce J., National Bank of South Dakota letter~.. . 1729 Walker, Charis E., American Council for Capital 1~'ormation, statøment.. - 1507 Washington Women for the Survival ofAgriculture, Janet B. Allison, letter.. 1721 Watertown (S.Dak.) Public Opinion, editorial 1723 Weatherford, Willis D., Berea College, letter forwarded by Congressman Romano L. Mazzoli 1571 Weber Gregor A. First National Bank of Philip, S. Oak., letter 1727 Weeks Silas B., University of New Hampshire Cooperative Extension Service, letter forwarded by Congressman Norman D'Amours 153 Wenning, Thomas F. National Association of Retail Grocers of the United States, statement 1551 Westf all, David, (Harvard Law School) Taxation With Representation, statement Wilson, Mr. and Mrs. Lawrence D., Sioux Falls, S. Oak,, letter 1748 Wisconsin, University of, Extension, Dennis D. Dornfeld, letter 1573 PAGENO="0013" XIII Page Wlttmeier, Maynard E.~ Herreid, S. flak., letter 1748 Wolk, Ted, Rapid City, S. Dak., letter 1748 Women for the Survival of Agriculture, Mar~y Beth Chess, letter 1715 Wyoming Stock Growers Association, Kim J. Krueger, letter 1569 Yeatman, Becky, National Organization for Women, Rapid City, ~. flak., chapter letter 1724~ Young ]Vfen's Christian Associations, National Board of, B. Stanley Enlund, statement 1532~ Zens, Audrey, Sioux Falls, S. Dak., letter 1570 Zumberge, James H., Southern Methodist Utiiversity, statement~. 1574 PAGENO="0014" PAGENO="0015" FEDERAL tSP~TE' AND GIfl TA ~ US MoND~r; M~RcH i~, :~9?~6 ` ~ ~ o~, ~E~Z~~rATIvzs, Co~MIwTE~1 ON W~xs 4~D Mw~s, Wa8ivbn.gtd~n, D.~ The committee met at 9:35 a.ni.~ ptirsuant to notjce, lxi the corrnnittee hearing room, Longworth House Office Building, Hon. Al Uliman (chairman of the committee) presiding. The ~ The ~o~ximittes will be iii order, please. Today the committee begins a series of public hearings on the yen important subject 0± estate and gift taxes Estate and gift ta'es have not been sub5tantinll~ revised fo~r some 40 years This serie$ of he~r~ mg~ will bt~xng to the committee in~ormation that will be useful to the committee in developing changes for estate and gift taxation at the Federal level We will hlsy, of course, have available to i~ts the datá~ on this sub~eot whic~t was pr~sented to the cqnxin,jttee `~ recent bearuigs in the pasL; , Without objection, I would like to include at this point in therecord the press release announcing these hearings [The press release foIlQws :j IPress re1èa~e of ~id~y, ~`eb.2O,1~6J CRAIRMAN An ULLMAN (D., OREGON), COMMITTEE ON W~.xs. Ai~m *~s tT.S. liotrsn or REPRESENTAtIVES, AN~tGt1NCES PANEl. DISdthssto~$ Alti) PuBLIC hE~3. INGS ON TIlE GENERAL SuB~ECE OF FEDERAL 33~S1ATE AND (~tfl~T TAXtS tOE TEE WEEx~or MARCII 1., 1976 The floiorabjo ~i~LJl1iuan Oregon), Chaitman, Committee on Ways and Means U S House of Representatives today announced that the Cotiniittee on Ways and Means would conduct ~auel discussions and public bearings beginning on Mouc~ay March 1~ 1976 on th~ general subject of Federal estate and gift taxes Ihese hearings wifl include thO recent proposals made by the President all estate and gift tax proposals which are presently pending before the Cern inittee on Ways and Means, as well as any other suggestions wlthai witnesses may care to ~uake on the general subject of estate and gift takes The hearings will be conducted in the Main Committee Rearing Room, aerees from Room 1102 1~ongworth Rouse Office Building, beginnfti~ at either 9 00 or 10 00 a m each scheduled day, depending upon the reqtiiremerits of the Corn inittee Witnesses desiring to be heard should sulxlrLit their requests to John ~ Martin Jr Chief Counsel Committee on Ways and Means Room 1102 Longworth House Office Building Washington 1) C 2O~15 not later than the alore of busi n~css Fri&r~ March 5~ 197~ It is ~ticipated that, either at the beginning of the hearing or before eomp1e~ tion of the hearing the Oonumlt$e ~v1U receive testimony from thS Secretary of the rreasnry and that during the course of the hearing certain specifically ii1~ vited witnesses will testify either ix~ panels or individually Panel arrangements v~ill be ma~1e by the staff It lb the Intention of the Conunittee to make every effort to complete tl~s hearing by net later than Friday, March ii) In view ~f the limited time available for the hear1ng~ and in antThtpation of the (1) PAGENO="0016" 2 large number of requests to be heard, it will be required that all persons and or- ganizations having a common position exert a maximum effort to designate one spokesman to represent them, making the oral presentation as brief as possible in order to enable the Committee to receive the widest expression of views, with the understanding that a more detailed statement can be submitted for review and for Inclusion in the printed record of the hearing. Any person or organization, instead of preseuti~igaz~ oral statement.~ ma~y file a written st~tement for the Committee's censiderátioli andfor printing In th~ rOcoi~d of thO'heáring. DETAILS CONCERNING THE SUD~TECTS TO BE HEARD Testimony will be admitted on.amendmgnts to all~spects of the present estate and gift tax laws. Thus; th~re will be InCIttd~d (1) thb~proposals of the Admin- istration; (2) proposals pendii~g before the Committee In bill form (for example, such amendments as those emlOdi&l iii H.R. 1793 (Congressman Omar Burleson of Texas), to in~rease the exemption for purposes of the Federal estate tax marital deduction, and to provide an alternative method of valuing certain real property for estate tax purposes) ; and (3) a~ny other proposals on estate and gift taxes which witnesses may care to present. DETAILS ~OR SUBMISSION OF REQUESTS TO BE HEARD Cutoff Date for Eequests to be Heard-Requesth~to be heard nmst be reó~ived by the Committee no later than the cZo~e of business Friday, `Mayo?~ 5.~Requesta should be addressed to John Martilh Jr., Chief Counsel, Committee on Ways and 1\~eans, V.s. House of Representatlv~s, 1102 Longworth House Office Building, Washington, D.C. 20515 (telephone: (202) 225-3625). Notification as to the witnesses's date of appearance will be made as promptly as possible a~fter the cutoff date, setting out details as to the format to be used by the Committee for the presentation of testimony, Once the witness Jias been advised of his date of appearance, it is not possib'e for this date to be changed, If a witness finds that he carn~ot appear on that day, be may wish to either substitute another spokes~ man In his place or file a written statement for the recerd of the hearing Instead of appearing in person. Due to the limited time available to the Committee for this hearing, it may be, necessary to allocate the amount `of time available to each witness for the pres~ entation of his direct oral testimony, If so, it will be mandatory upon all wit- nesses not to exceed the tipie allocated ,f~r this purpose. If the witness wishes to submit a more detailed statement, it will be reviewed and included In the record of the hearing, , ,. Requests to be heard must contain the following information 1. The name, address, telephone number, and capacity in which the witness will appear. 2. The list of organizations and/or persons the witness represents, and in the case of associations and organizations their address and where possible a mem~ bership 11sf, , ` 3. If a witness wishes. to make a statement on his `owt behalf, be must still nevertheless indicate whether he has any. specific `clients who have an' interest iii the subject, or in the alternative, he must indicate that he doet hot represent any clients having an interest,in the subject he will be discussing. .4.. The pro~Islons of the estate and gift tax laws on which the witness will be testifying, incjuding .a topiCal ~outline or summary of the comments and ree~ opimencations to `be presep'ted.' If it is necessary to allocate time to `each witness, `this amount of' time will be strictly enforced. Witnesses are urged to verbally summarize their statements; the complete statements will be `carefully considered by the members of th'e Coin- mittee and included In the printed record of the hearing. It is requested that persons scheduled to appear before the' C"ommlttee submit 75 copies of their prepared statements to the Committee Ofilce no later than 24 hours prior to their scheduled appearance. An additIonal `75 copIes may be `fur- nished for distribution to the. press and' the interested public on the date of appearance. Ahy interes1ie~. person or organization may, Instead of a personal appearance `ifie a written statement for inclusion. In the printed record of the hearing. For this purpose, ~ve copies' should be submitted by the close of business Friday March 19. Addltl;onal `copies may be furnished f&r distribution to the members of the Committee, the staff, press and interested public if submitted to the Com-~ mittee during the course of the public hearing. PAGENO="0017" . 2 The CR~E~4~. Weare going to :b~gii~t9 :3O~&wh ~Gndng this week and hear a series of pub~o witr~esses ~r~nged u~ pai~eIs On next Monday, March 22, we will hear from the Treasury Department On Tuesday, March 23, we will hear two panels~ of experts especially invited by the committee. Our first witness this morrnng as our very distinguished colleague in the House, the Honorable George Malion, chairman of the Appropria~. tions Committee. Mr. Mahon, we are pleased to have you here to give testimony on this important subject. I yield to our d~stinguisbed colleague, Mr. Burleson. Mr BURLESON Thank you very much, Mr Chairman, for giving me the oppo~tunity~of weh~omingmy colleague from1 Texas who is chair- man of the Appropriations Committee but who~ is now the dean, not ouly of the Texas delegation, but also of the entire Congress I take personal pleasure in presenting him to the committee. lie doesn't ueed introduction, but it is my pleasure to welcome my colleague to this hearing. The CHAIRMAN I yield tQ our other distinguished colleague from Texas, Mr. Pickle. Mr PIcJu~E Mr Chairman, I thank you for yielding I also want to welcome one of the most distinguished men who ever served in this Congress I am glad to see him here I would like consent to have ray remarks made a part of the record immediately following those of Mr. Mahon. As you may know, Mr. Burleson. and I both have introduced a com- panion bill on this subject I would like my remarks to follow those of this istinguished gentleman. The CHAIRMAN Without objection, it will be so ordered I am very glad, Mr Buileson, that you pointed out that our distinguished wit ness this morning is now the dean of the House and we commend him The gentleman is certainly one of the most distinguished of all Americans. We will be pleased tohear you. SThTENENT OP HON. GEORGE H. MABON, .A REPRESENTATIVE IN CONGRESS PROM THE STATE OP TEXAS Mr. MAHON. Thank you very much, Mr. Chairman. Thank you 4/ery much, Mr Burleson and Mr t~ck~e for the commercial I don't know just how advantageous it is to be the dean of the House of Repiesenta- tives and of the Congress. I think we look more these. days to~the quality of performance rather than to the length of service The CHAIRMAN. The gentleman exceisii~that too. Mr MAHON Thank you so much The gentleman from Texas, Mr Burleson, introduced a bill involving Federal estate taxes ~onae time ago We discussed this matter and I was delighted to become also a cosponsor of this legislation because, in my opinion, it is legislation of a very great urgency I am not a student of Federal estate taxes I am here because many of my constituents of relatively moderate means have expressed to me the view, which I fully share~ that the present $60,000 exemption which was written into the law about 34 years ago is inadequate in the context of existing conditions. 68-872-76--.---2 PAGENO="0018" 4 In ~ opinion it is mueh too low and should be increased, and so I have joined with Mr Burleson and Mr Packle and othe~ts to try to give impetus to the idea of raising the $60,000 limit I hope the Ways and Means Committee will .fli~d `a wa~ to' `provide an appropriate increase. Mr. Chairman, I want to commend the Ways and Means Committee for scheduling this hea.rmg because this matter is more important than it may appear to be on the surface. I realize that, of conrse, there are many complexities in our estate tax laws. I' `know you will be re- ceiving testimony from the experts in this field. I represe~ft a~ great'fa~'min~ ái~ea and what ii'flation has done to my great `farming area is really something to behold. it costs money, money, money to engage in the farming business Many piece~of farm equipment will cost'you as `much aS $25,000. it `isn't unuSual to have a $50~000 `or $l00~000 or more investment in e~p.tipment and machinei~y alone. Then `land values have skyrocketed far beyond their productive potential. In other words, speculation in real estate ventures and otherwise has cthised the land to increase very significantly' in market value. So the $60,000 limit: even for people of moderate means is now en- tirely tao low and I would hope that we can find a way to deal with :t!his subject. If `we can't deal with' it adequately, it is going to have a very adverse effect, in my opinion, on agricultural production Therefore, it is not only important to farmers~to agiiculthre-~but it is important to city dwellers, to people in the urban areas, to the rank and file workers of `the country.: ` ` That is about all I would say, Mr. Chairman~, because I want you to hear the `witnesses who are e~p~erts in the field. The CHAIRMAN4 Thank you very lunch. Wouldn't you agree with us that a Presidential year is a difficult year to `handle this matter, but `wo came to the; conclusion that the `problem was so serious that we couldn't afford to delay it any longer. Would you agree with `that? Mr. MAHON. I fully agree. Ihave been `rather surprised and pleased, and yet I understand it, that there has becn so much interest in this by the farm org"~~i~ations and others whose problem it is and whose duty it is to be re~ponsive to the needs of agriculture. Mr. SOHNEEBELI. Mr. Chairman. The CHAIRMAN. Mr. Schneebeli. Mr. SCHNEEBELL Mr. Chairman. We all have great respect for the chairman of the Appropriations Committee. The House Members, of course, are guided by the thoughts of their seniors and certainly Mr. Mahon has the respect of everybody `in the House and I am sure that his thoughts will be weighed very carefully. I support `the position you maintain. I think you are absolutely correct, Mr. Mahon. Thank you very much for coming. Mr. MAIION~ Thank you very much. Thank you, Mr. Chairman. The CHAIRMAN. Mr. Burke. Mr. Btmm~. I wish to commend the chairman for his appearance here this morning. I am surprised to hear that he is the dean Qf the House. He has such a youthful way about him. I thought he was one of the new Members. PAGENO="0019" `MI'. ~[A1~O~. Tha~nk ~yøu very much for ~yow u~ialit~y. `±hat brig'h~tens up n~r day~&. Thirke. `The x~tnu~UN. Are ~ui~the~pstionsL. We aFprecia~c yo~tr ~o~niñ~ ~The remarks of Congressman Piçkl~, previously referred to, f~l1ow:] t~rE~ENT ON ~E8T~A~E PA~ D~ flO]~. ~. ~T. P~KtE~ A flE~?a~sEwrA~vE IN ~ OF `i~E~AS Mr. Ohttrman, ~tethbe~,' I ~ on~sup~x~t ~ the ~U IIJ~ 19~3 by Mr~ ~urIeso~ and the e~rn~anioi~, b4J1 B~ ~ w1~ch I ~ave int~~ced~~ BOth 41)1115 Wufltd I e~tse `the esmte I tan~e tax froui. the present amoun~ O~ $~O,OOO to'$~OO,OOG. T~h4~ oommittee and thisMØngi~ess has a ehanee to$~eathe new~ life into `one of our ~e'áteOt 1nstitutiou~'Whtt~b~ been graduä1l~ erbdil~ in tho'flist few yOats-~- the faniili far~u~,. F~ew `ins U1~tDtis j~, this ootmti~y hav~ been. flmre vahiable- Surveys by widely divergeut economists lia~ve stated timt the ~fam'iiy farm is ~tbe most p~oductlve"unit of food und ñber j~roducttOn. AntI the fartile;s "alId rats)1lers of this coiflitr~r i~5ire asked. i'lt'tis i~i t~et*tii. Th~t~nc~cv tbe~ are ~le~dihg that this present, `badly outdated law be updated SO that the family f~r~' can be passed from generation to generation, Whenever I talked wit1~ the people ~f the 10th DistrIct of Texas about agricul- turè, there is one aebjeot wrbiéh dominates l~h'~s~ ~on rsa't1ons~ `it is the estate tax. When COngr~ss established the ~60,O00 exemption the year was 1$42.. I do not have the precise figures estimating the iberease 11n land. v~iues durin~ the last 34 years b~t we all kIiOw that it has been significant-a four or live times increasO in value in mo$ s1a~kces. There has been a do*~tnlflU'alid.e in the `~nnm~r~o~ ~ar~mns during the last two decades. In 1955, there were ies Congressional Districts where at least 20 percent ot ~the folks lived, on ranches ~r farms. Today' there are only i!4 ~s~Ich ~1i5W.ets. Sjn~e `1970, `the pensu;~ B~p,ean tells us a, very slight reverse, of the, tirbitu mi- gration has begun. I thin~ç',~Ila~ sucin a ~nove is encoUtagt~g, Mn~riea will~ecnitiiwe to enjoy the finest food j~totIti~tion systOm in the wor],~L ohly as lông ~ts the family ~tarm remains the ba~th `unit. fly~ passtn~ legislation ~vhieb ~4fl lncn~ease the ex- emption to ~200,O00, we ~wiii be Onsurkig that `more farms stay tn the hands of the family. Under th~preSe~t systeiz~,~ i~ny landownhers' heft~: `are `~forced to sell out to developers, or to the govehmient, so that they can p~y the inheritance tax. I believe that this Is counter-prOductive to oui~ eeonoin~r 10 the long run. If `you support the family-farm `and do not Want ott food DrOdUction eontr~1ied by a handful of multinational corporations, I think this committee will, support the Burleson~P1ok1e'bfti. " ` ` Some may say this IS an e~tra taN `advantage for the rich. I suppose it wou]4 help the rich slightly-but the rich (whoever the jo'urnaftsts classify as "ricb~') are not the object for relief in this l~i1l. `The 1)111 is `designed' to help those~aver- age home-farm-ranch estates-300--600 acres in size. Unless we give relief to those groups-few farmer~ will be able to pass along their estate, or part of their estate, to their children, All that most farmers and ranchers have is their land. If that must be sold, then the farm is automatically broken up. The average .`farme± just keeps a~head of tile bill cOllector anyway. lreW farlilers can accumulate $50,0000$100,0® in cash to pay the federal government. I must add that I am giadmat the President has come around to our way of thinking, although lie advocates an Increase, to only $150,000. fl's proposal is firm evidence, though, that there is broad4ased support for reforkrilng this an- tiquated law. The CIIAnu~w~. Our neit witnesses th1~ rnornin~ are a very clistlu- guished panel' `that we will call to the witness stand, Mr. Allan Grant, president of the American Farm' l3ureau~F&tsration: we l~ave l3arbara Brookshire from the &ssóciated Milk Produèers c~i:ia-state 1~egion~) Women's Auxilia~ry; Albert FL Geiss, Tuternatienal M ciatioti o~ Ice Oream Manufacturers, Milk Industry Fo dt~ti~ii~ L. C. Cai~pen- ter, vice president of the `Mi'!k&ntineiit rarthcrs Association; Mn. W. B Oriswell, president, Plains COtton Growers Association; and Mr. PAGENO="0020" 6 Don Woodward, who is the president of the National Association of Wheat Gro~'er~, the ad hoc agricultural tax committee I want to welcome all of you to the committee. I take special note of Mr. Don Woodward, who ha~ been a friend of mifie for many years. We were ii~ college together. ITe is from my disti~'ict and is the very distinguished president ofthe Natibnal Associatioii of Wheat Growers. A PÂNEL cONSISTING QP L. C. C~PENTER,. VICE PRESIDENT, MID~ CONTINENT FARMERS ASSOCIATION; ALLAN GRANT, PRESIDENT, AMERICAN FARM BUREAU FEDERATION; DON WOODWARD,NA. TIONAII ASSOCIATION OP WREAT GROWERS AND AD EOC AGRIcULTURAL TAX COMMITTEE; BARBARA BROOKSHIBE, ASSO~ CIATZI~ MILIC PRODUCERS (MID STATE RZGION) WOMEN'S AUX~ ILIARY; ALBERT E. GEISS, INTERNATIONAL ASSOCIATION OP ICE CREAM MANTJFACTVRERS, AND MILK INDtISTRT rOuNDATIO~t, AND W. ]3. CRISWELL, PRESIDENT, PLAINS COTTON GROWERS ASSOCIATION The CHAIRMAN. We will leave it to your judgment as 1~o who shall lead off. Mr. Carpeliter, would yOu like to lead off this morning? STATEMENT OF L. C. CAR?~NTER Mr. OARPEN~ER. Mr. Chairman and members of the committee, I am delighted to have this opportunity. I appreciate the courtesy of iead~ ing off because I do have another meeting at 10 30 Mr. Chairman, may I say from, the standpoint of farmersprobably their No. 1 worry today is prices, but their No. 2 worry is the fact that they know they are going to pas~ on and they are wondering what is going to happen to their relatives in the way of tax payment when that happens. So I will brief my statement if it might be placed in the record. The CHAIRMAN. Without objection, we will place it in the record in full. Thank you, Mr. Carpenter. [The. prepared statement fellows:] SPATRMENI' OF L. 0. "CLELL" CARPENTER, MTDCONFINRNP FARMERS AssocIArroN, COLUMBIA, MISSOURI Mr. Chairman and members of the committee, I am L. C. "Oiell" Carpenter, Vice President of Mideontinent Farmers Association, headquartered in Columbia, Missouri MFA is a farm organization representing o~ er 160 000 farmers in the mid-centralIJuited States. Mr. Chairman, this committee Is to be commended for boldthg these hearings on the vital subject of estate taxes. The American dream has always been that an individual should be able to build an estate for his own enrichment and which hecan pass on to his children. It is this building up of one generation after the next which has made our country great-whether economic, social or political. But economic growth cannot continue at past rates under the current estate tax situation. The present $60,000 exemption which was realistic 40 years ago now results in an estate tax which is confiscatory. It is Important that future progress Snot be inhibited by tax policies Of the past. It is essential that the hulk of our na- t1on~s farm land not pass into the hands of large corporations because estate laws force the heirs to sell their family farm to pay the taxes, PAGENO="0021" 7 Quite frankly 1\4i~ Chairman I believe your dynamic speecb a few weeks ~tgo did much to convinee the President that a higher estate tax e~eniptIon Is neces ~ary Your promise ` that the averág~ fairnly farmer will get ~re1iet frofli the revisions ` to be written by th1~ conimittee p~u~ the lack oi~ ex~t1iusiasm i~or the President s proposal, ni~i~t have pursuaded the President that a higher exemp tion is needed. His origlithi propo~a1 éalled only for extetidlng the time over which estate taxes eould be paid. * . ~ ` Now the Presi4ent is calling i~or a substantial, although inadequate increase In the estate tax exemption In 1942 when the $60,000 estate tax exemption was established, the average equity per farm was about $10,000 If farm equities continue t~ grow as they have in the past in JIve years the average farm equity will rise to about $2S~ 000 per farm. Mr Chairman in order to enhance continuation of the famui~ farm and other small businesses, we favor the following legislative proposals: 1. Increase the estate tace ecvempti&n from the present $60,000 to `$200,000 The combined Influence of Inflation in general, and speculation In farm' laud in particular have caused farm land prices to increase at a higher iate than general prices Therefore, the present exemption established 8~& years ago is no longer adequate. We do not propose perpetuating large fortJIues, and are against the develop ~nent of a feudal system based upon a hereditary land~ownlng class~ ~~e~do strongly favor continuation of family farms and small businesses A realistic evemption of $200 000 wIll euhance continuation of family sited farms ai~d busi nesses A progressive 1i~ier1tance tax on that portion not exempted will limit the growth of large estates. We favor making the $200,000 exemption apply to all estatee-both farm and non farm Although farming requires greater capitalization than other businesses (making it more difficult for young families to enter farming than ot]wr busi- nesses) farmers do riot desire preferential treatment, 2. Increase the marital deduction by ,a fiat sum of $100,000 beyond the present one-half deduction now aflowed It is impossIble to measure the inputs contributed by a fi~rm wtteto the total increase in the value of a farm The same is true of family businesses The $100,000 marital deduction would reflect contributions made by the wife In addition it would help to overcome another problem related to the surviving' wife of a family farm or business Often a ban1~ will not loan a widow funds necessary to carry on the business until she is able to demonstrn.te her abihty to manage it. , 2. Evaluate real property including farming, woodland, and scenic open space, on the basit Of current `use rather than. potential use Land adjacent to municipalities is often value on its potential development value. Likewise, speculators drive up the price of land beyond its preductive value because of tax loss considerations Those who hare owned and operated land for farming rather than holding It for speculation should not be penalized by having their estate valued and taxed at a level other than its productive value. 4. Delay'estate taees fOr,thc first 5 years following the death of the owner, with no interest duO o~i the taces during that period This delay would provide the heirs ample time to assume operation of the farm or business, establish credit, and make the necessary management decisions before the added burden of estate taxes would become a factor. 2. Require payment of'estate taces dnring the `~ia'th through tweri~y~fifth years, with an interest of 4% during this period on the unpaid balanee 6. Re~cal the provision that makes the ececutor of an estate liable for the estate taees, when the stretched-out payment piani's being uset Repealing this liability provision would enhance the securing of professional help in admInistering estates. Mr chairman the role of the family farm in. assuring adequate supplies of food and fiber for both domestic use and export is such that we must have bipar tisan support for its survival. ~lquitable estate taxes can do munch to provbte such assurance Tax revision plans now before the Congress have merit, and deserve your fullest consideration. PAGENO="0022" 8 The CHAIRMAN. I will recognize Mr. Allan Grant, president of the~ American Farm Bureau Federation. Wheni appeared before your national convez~tion this subject mat~ ter wa~ raised as one of the most important of all the matters in which ycni felt the Congress should take action. We are pleased to have you. here before us, Mr. Grant. STATEMENT OP ALLAN GRANT Mr. GRANT. Thank you, Mr. Chairman and menibers of the com~ mittee, we appreciate the opportunity to present Farm Bureau's views on amendments to update and reform. the provisions of the Federal estate tax law. Farm Bureau is the largest general farm organization in the United. states with a membership of 2,~05,~58 families in 49 Stateeand Puerto :aico. It is a voluntary, nongovernmental organization representing farmers and ranchers who preduce virtaa1l~~ every agricultural com- modity that is produced on ~ commercial 1~asis in tl~is country. As a. conseqnencc, we have a deep interest in all Federal' taxes, including~ estate taxes, that affect ourfarmars arid ranchera Estate taxes have been a matter of increasing concern to Farm. Bureau members for several years. Farming and ranching arc predom- inantly family. enterprises, and farmers and rain~hers are deeply in- terested in the orderly transfer of their businesses, 4o succeeding generations. The Federal estate taxis es~eñtialiy the same today as it was in the 1940'a The last significant ehange, the addition of the marital deduc tion, was made in 1948 The present rates arid ~cheduIe~ were adopted in 1941 and the present specific exemption went into effect in 1942 Since the basic provisions of the present estate ta~ weie adopted, the purchasing power of the dollar has been eroded by inflation, and the size and the value of an economic farming unit have undergone drastic changes. In 1942 the U.S. average value of land and buildings per operating farm unit was only $6,100, and' very few farmers were affeeted by the Fe4eral estate tax. In March 1975 the average value of land and buildings per operating farm unit was $t43,000, and the amount 0± machinery and equipment required toopera.te a farm waarnuch greater than in 1942. As a result, estate taxes have become a matter of deep concern to a great many farmers. The impact of the estate tax on farmers `is `g~teathst on the estates that consist primarily of efficient, productive commercial farmmg operations and thus do not have large amounts of liquid assets that can be used to pay estate taxes. These a~'e the farms that produce the bulk of the farm products that' have made American agriculture the envy of most of the rest of the' world. Higher estate taxes brought on by inflation and estate ap~ praisals based on' the mark~t value of farmland for nnnfarmn uses are making it increasingly difficult for farmers to transfer' family farm- ing businesses to succeeding generations and are threatening to elnn~ mate farming and desirable privately owned open space from many populous areas.' PAGENO="0023" 9 When a fanner or rancJ~er dies, 1~is li eh~oft~n f1~d ~them~eii~es i~aced with such high estate taxes that thcy are forced to sell they £a~m or rauch rega~d1ess o~ t1~x~ desrre to 1~ee~p it in bhe family Uufortu nately, many fainiIic~ a~re ziot aware of their potential Fed~ra1 estate tax liability u~it~l after an unexpected death Thus, farm families often fail to take advantage of the numerous provisions of the esta~te and gift tax laws that can be use4-with the help of proper legal advice-to re~duce, or postpone, estate ta~xes Our policy with respect to estate and gift taxes was summarized in a policy resolution, which was adopted by the voting delegates of the member State farm.bure~us at the 1976 annual meeting of the Amer- ican Farm Bureau Federation in St Louis, ~Io, last January, as follows Laws covering the taxation of eStates and gifts have not been changed fl~aterl- ally siuce 1~t2. We place a high priority On ma~Q~ amenchxiei~ts to the estate am~l gift tax pi~ovisions of the Internal Revenue Code,~ ~t a minimum, thes~ Amendments should include (1) an increase in the standnr~~ estate tax exemption to reflect the effects of inflation since the present $6~ 000 ezeihption wAs 5Sf iii ~1942 (2) a substantial incregse in the marital dedUction to miI4u4ize the problen~ of the so ~alled widow's tax ,and (8) provisions for basing the value of farmland and open spaces at levels reflecting their eurrelit use rather thaA their highest pos- sible use~ Imtaediate passage o~ such legislation Is p4c~ssary If we are to allow farms and. small bn~inesses to be, passed, from one generation to another if we are to relieve unnecessary hardships on widows and widon ers, and if at the same thne,we are to maintain open spacesiu'urban areas. `1~o offset the cumulative effect of more than 80 years o1~ inflation and to help check the adverse effects o~o~tate ta~çes on congestion and iirbau sprawl in populous areas, Farm Burean recommends three changes in the present Federal estate tax law as follows One Raise th~ specific estate ta~ e~empt~cm from $60,000 to $~00,000 This would adjust the estate exemption for the inftation which h*as occurred since 1942~ when the $60,000 exemj~tioa went into effect The Consumer Price Index-1967=i00-was 48.8 in 1942 and 161.2 1ni'1975~ This means the purchasing power of $1 in 197~ was about equal to the purchaMng power of 30 cents in 1942, and $60,000 divided by 80 cents equals $200,00Q. Two fla,ise the maximum marital deduction from 50 percent of the value of the adjusted gross estate passed to a ~urvivmg spouse to $100,000 plus 50 percent of the total value of the adjusted gross estate This would recognize the importance of partnerships between hus bands and wives, and the special problen~s of wives who are widowed at an early ageS . , `Fhree Establish a procedure which would permit the ectecutor of an estate to elect to have land used for farming, woodland or scenic open space assessed for estate tax purposes on the basis of its current use rather than higher potential uses. We are grateful to Congressman Burleson and the approximately 100 other Mernbers of the T~ouse who have introduced, or cosponsored~ bills to carry out these recommendations We are well aware that our proposals will be opened by some people on the grounds of cost to the Treasury. We do not think this is a valid. PAGENO="0024" 10 argument. Estateand gift taxes are a' relatively thinór source of Fed- oral re~ven~ue. `In the fiscal year 1975-the last ye;ar ffr*hich final figures are avail- able-~Federal revenues from estate and gift t'txes amounted to only $4.6 billion, or 2.5 percent of the $187.5 ~biliion the Féd~ral Govern- merit received in general revenues-that is,' Federal revenues from all `sources except trust fund~. The fact of the matter is that the basic purpose of the; Federal estate tax is to redistribute wealth rather than to raise revenue. Our proposal with respect to the specific estate tax exemption would apply to all estates. `If a specific estate `tax exemption of $60,000 was justified `in 1942, an increase in this exemption to $200,000 is fully justified to adjust for the inflation that has occurred since 1942. Our proposal with respect to'the maritaFded'uction also: would apply to all estates. This deduction is essentially a device for deferring `estate' taxes until `the dea1~h of a surviving spouse. As a matter of equity, we do not think that a tax should be levied on the transfer of property between spouses on the death of' a husband `or wife however, we `are not recom~iending a 100-percent marital deduction. The increase which we are proposing is designed to provide a measure of relief for the estates that most need it. Our.proposal with `respect to the valuation of farmland, woodland, and open space would apply only to estates that own such land, how- ever, we believe that it would serve the public interest by helping to maintain open space in urban areas without extensive public expendi- tures for land acquisition and maintenance. We would like to stress the fact that this proposal would be optional rather than mandatory. If an executor elected to have an estate as- ~essed at its value for `farming purposes, the land in the estate would he required to remain in farming or ranching for a period of 5 years. If' such land is sold `for a nónfarm use in less than 5' years an addi- tional tax based on the higher use value would be assessed and col- lëcted. We are recommending that the recapture period be limited to 5 years because a longer period could create a hardship by clouding title to the land in an estate and thereby impairing its collateral value. We also would like to point out that one effect of having land valued on the basis of its current use-rather than a higher market value- would be to increase the amount of capital gains that would be realized and subject to taxation if the property should subsequently be sold for more than its current u~e value. We appreciate the opportunity to present our views on this impor- tant matter,' and we urge that you take prompt and favorable action on our proposals, so that remedial legislation can be passed by the p4th Congress. Thank you very much. The CHAIRMAN. Thank you, Mr. Grant, for a very concise statement. We will next hear from Mr. Don Woodward, president of the National Association of Wheat Growers. Welcome to the committee, Don. PAGENO="0025" 11 STATEMENT OP DON WOODWA1~D Mr. W000wAiw, Thankyou., Mr. Chairman. A good many years ago when you and I were college students back in the late thirties we never would have thought we would meet here today. Things were real carefree in those days. Now we have problems and we are glad that we have you where you are so that you can help with all of the major problems that face the Ways and Means Committee. Mr. SCHNEEBELI. If the gentleman would yield, Mr. Woodward, we also are very happy that we have Mr. Ullman for a chairman. The CHAIRMAN. I appreciate that very much. Sometimes I wish someone else were shouldering some of these responsibilities. You may proceed, sir. Mr. W000wAiw. Nevertheless we have a job to do so that we will proceed. Members of the committee and Chairman Ullman, let me first take this opportunity to thank you for allowing me to appear before you today. I should first say that I am appearing not only on behalf of the1 National Association of Wheat Growers, but also on behalf of an ad hoc agricultural tax committee This committee includes the American Horse Council, mc, American National Cattlemen's Association, American Seed Trade Association, American Sugar Cane League, Cotton Warehouse Association, Florida Sugar Cane League, National Association of Wheat Growers, National Cotton Council of America, National Milk Producers Federation, National Wool Growers Asso- ciation, and the Rio Grande Valley Sugar Cane Growers Cooperative In this regard you have already heard testimony from some of these people that we have here today and in the interests of time we rsalize that our remarks should be made briefly and we ask that all our testi~ mony in the written text be included in the record. The CHAIRMAN. Without objection, your statement will appear in full as though read and the same is true of all Of the sta~teinents. Mr. WOODWARD. Thank you. There are two primary factors that have contributed to the need for updating the estate tax laws for agricultural estates-~infiation and increasing farm size. Along with increased farm size h~s cOme an im- proved technology in which specialized equipment is being substituted for farm labor. Based on U S Department of Agriculture figures the average farm in 1942 had 182 acres and its value, including buildings, was $6,100 There are no records of the average v%lue invested in farm equipment and other personal property at that time, but even when the value ~f personal property is added to the real estate value, the total was far below the $60,000 estate tax exemption. It is our conclusion that a farm had to be five or six times larger than the average farm in 1942 before it even began to pay an estate tax. The 1975 situation is far different. The average farm now has 88 acres and, with buildings, is worth about $131,000. In view of this, we believe it reasonable to project that the invest~ ment in farm personal property is equal to that invested in real estate. For the average farm cited above this means another $181,000 or a. PAGENO="0026" 12 total farm investment of $262~O0O. Subtract the $60,000 estate tax cx- ~emption and there is a taxable estate-in round figures-of $200,000.. The estate tax on such an estate is $50,700 on a direct inheritance. In the case of a surviving spouse, *ho in most instances has been directly involved in operating the farm along with her husband, there is a fax of about $9,000. it is the impact of these levies which we find alarming. The income potential of farming operations does not have within it a tolerance which can. pick up a $50,000 estate tax bill. And if the property is valued' at other than agricultural values, the tax burden becornes'even greater. There is an alternative to family farming, but it is one we do not like and we believe the. Congress will like no better. It is total corporate farming financed solely `by outside capital. We do not `believe the Con- gress prefers this type of farm ownership to the present family farm ~structure. Yet, unless action is taken, the family farm will go down the. drain. It is imperative that we do something al~out this today as well as in `the. future. Fortunately, many Members of Congress., as well as the President, have, come to recognize the problem. President Ford expressed con- cern about the situation in his state of the Union message and advanced one type of relief. The legislative branch of Government has. shown an equal interest. Numerous bills have been introduced in `the Senate to `adjust the estate `tax laws to maintain the family farm. Here in the House the. record is even more impressive. A very large number of bills h'as been introduced to rectify `this situation. Among `the proposed estate tax relief measures there are four main categories which I feel are imperative to the interests of the farmers. No. 1 would be that if there is one measure which hns almost uni- versal support within the farm community it is' the ~proposal to allow farmland to be valued on the basis of its use for farming purposes rather than the value on the basis of fair market value. This is the type of relief `proposed by Mr. Burleson's iegislation-~-H.R. 1793 and other identical bills-which at last count `has 63 cosponsors. Under the Burleson `bill, land must continue to be held and used `by the estate beneficiaries as farmland for at least 5 years following the ~death of the `decedent in order to qualify. The law now requires' that property `held at death, including farm.. land, must be included in the estate at fair market value. A large estate tax liability resulting from the valuation of farmland on the basis of its fair market value has caused in the past `and continues to cause severe financial problems for the surviving members of a family. `These people are forced to sell all or `part of the land in order to meet t'he estate tax `bill, or they are forced to abandon the use of the land for farming purposes and convert it to nonagricultural uses. By limiting the factors to `be used in the valuation of farmland held ~by an estate to the use of the land for farming pui~poses, this clearly eliminates inflated values due to urban development or due to valua- tion on the basis of a more profitable use of the land. it is noteworthy to take `notice that 31 States already have laws PAGENO="0027" 13 &llowing property ta~ valñations of fa~rmi~ndto be made on th~ basis ~of use of the lands Mr. Chairman, for reasons E have discussed and also in ~ur Writ- ten testimony we strongly u~g~ the com~nittee to adopt a pro~rision to allow alternative valuation of farmland based on its use for farming. No. 2: Next let me turn to t3h~ proposal to increase the current ~$6O,0OO estate tax exemption to. some higher amount. Most sponsors have snggested arise to ~2O0~000 in order to fully take into account the rate of inflation since the $60,GO0 exemption was en- acted. Our organization has recommended a $300,000 exemption. The Presid~nt, on the other hand, recently called for an increase to $150,000 to be phased &it ~rer e~~year period. Regardless of the figure, some substnntial increase in tlie'present ex- e~nption i~ cl~arly warranted. Because `upthtting the exemption is long ~os~etdue, we favor adjusting it immediately, rather than phasing it ~out over a period of years. I say this from the farmer's point of view because, as meirtioned e~r- her, the amount of oapital invested by the average$arm in such things ~as farm equipment, livestock, ai~d other assets necessary for farming has risen dramatically over recent years, The proposal to value farmland on the basis of farm use does not provide any estate tax relief for the substantially higher value of farm property other than land. And we believe this prOblem should also be dealt with. If farm equipment or other essential assets have to be sold i~o pay estate taxes, the effect is the same as having to sell or convert the iarmland itself. Before turning to the next proposal, let me make it clear that we are suggesting an increase in the exemption in addition to valuation of ~armland based on use-~--not in lieu of this latter proposal Next, I would like to briefly comment on the Presideut's~proposal to allow a 5-year moratorium on estate tax liability attributable to family farms or small tusinesses followed by a 20-year installment payment period at an interest rate of 4 percent rather than the current ~ percent. As with other proposals, this would be quite helpful to many farm- ~ Howe~rer, we do nOt belie~ s1*~ding alone it provides sufficient relief. Conscqueiitl~r, it ne~e~sa~rily m~t be coupled -with ~óme or all of `the other proposale I have mention~cL The fourth proposal is that ethers. will ~no doubt discnss in great de- -tail an inor~ase in the ~0 j~e~cent n~arital -deduction. For that reason, I will limit my comments b~ st~th~ihat, such ah hi~cre~the would ob- viously be helpful to everyon&-~ariners included-from at least two standpoints. It could -eliminate estate taxes on the farm property left i~he survit~ing spouse and could also eliminate the complicated and often expensive estate planning now required to minimize takes on the estate -of the first spouse to die. , Finally, w~ want the com~iittee record to clearly show that our group' oppo~e~ a c*pital gains th~ `on appreclated propei~ held-at death. In the case of farmers, tlie farmland help at death has' o~ften `ap- ~preciated greatly over the cost when originally purchased or when in- herited. A large capital' gains -tax ~n this appreciation would `again `force the sale of the iand in order to-meet the tax liability. In closing, I would like the committee to know that by co~nmenting on the problems of farmers, w~ do--not mean to imply there are not PAGENO="0028" 14 many other citizens who encounter seriou~ problems because of the present estate tax law. We realize that you must deal `with the problems of the farmer within the context of small business owners and other taxpayers, and also within budgetary restrictiOns4 Nonetheless, within this context, we hope that the committee under- stands the plight of the farmer when considering estate tax changes. We urge you to adopt relief provisions along the lines suggested. `Thank you again for allowing me to present our views. [The prepared statement follows:] STATEMENT OF' DON WOODWARD, PRESIDENT, NATIONAL AsSoCIATIoN OF WHEAT GROWEES, AND ON BEHALF OF THE AD Hoc AGRICULTURAL TAX COMMITTEE Chairman TJllman and memher.s of the Committee, let me first take this op- portunity to thank you for allowing me to appear before you today. I should fir~st say that I am appearing not only on behalf Of `the National Association of Wheat Growers, but also on behalf of an Ad Hoc Agricultural Tax Committee. This Committee inclu'de.s the American Horse Council, Inc., American National Cattle- men's Association,' American Seed Trade Association, American Sugar Cane League, Cotton Warehouse Association, Florida Sugar Cane League, National Association of Wheat Growers, National Cotton Council of America, National Milk Producers Federation, National Wool Growers Association, and the, Rio Grande Valley Sugar Cane Growers Cooperative. In this regard, I should mention that some of the members of the Ad Hoc Committee are also presenting their views individually to emphasize the most important areas of concern to their particular segment of the farm community. The Ways and Means Committee is to be commended for calling `these hear- ings to review the estate tax laws. Such a review, particularly as it' relates to es- tates in which the principal assets are a family-type farm and' the personal property needed for its operation, i's, in our opinion, long overdue. It i~ probably not an overstatement to say that estate tax reform for family farms is one of the most important of all farm issues now pending before Congress. Two primary factors have contributed to the need for updating the estate tax, laws for agricultural estates-inflation and increasing farm size. Along with increased farm size has come an improved technology in which specialized equipment is being substituted for farm labor. The inflationary spiral, common to all of us, seems to have Impacted more on agricultural than on the general economy. Since 1942, when the present $60,000 exemption was established for estates, farm real estate values have gone up some 1000%. Values today are three times higher than they were In 1960. `Compound this increase in value `by the fact that farm size on the average has more than doubled since 1942 and we find ap entirely different situation today than we had in 1942 or even in 1960. Based on tLIS. Department of Agriculture figures the average farm in 1942 had 182 acres and its value, including buildings was $C,100. There are no rec- ords of the average value invested in farm equipment and other personal prop- erty at that time, but even when the value of personal property is added to the real estate value, the total was far belOw the $60,000 estate tax exemption. It is our conclusion that a farm h'ad to he five or six times larger than the average farm in 1942 before it even began to pay an estate tax. The 1975 situation is far different. The average farm now has 885 acres. `and, with buildings, Is worth about $131,000. Because of the great variety of farming in the United States (and within the group presenting this statement) it is difficult to place an "average" figure on farm equipment and other personal property. However, we do know that every type of agriculture today has costly highly specialized eqnipme~t, whether It be a tra~tor, a combine,, a mechanical cottoi~ harvester, self-propelled picker-sheller used in harvesting corn or a stainless steel pipeline milker `and storage tank on the dairy farm. In the case of livestock farms, large sums are invested in breed- ing animals and other livestock. In view of `this, we believe it reasonable `to project that the Investment in farm personal property i's equal to that invested in real estate. For the average farm cited above this means another $131,000 or a total farm investment of $262,000. Subtract the $60,000 estate tax exemption and there is a taxable estate (in round figures) of $200,000. PAGENO="0029" 15 The estate tax on such an estate la $501T00 on a direct inheritance. In the case of a surviving spouse, who lxi ~xiost instances has been directly involved in op~ erating the farm along with her husband there Is a tax of about $9,000. it is the impact of these levies which we find alarming, The income potential of farming operations does not have within it a tolerance which can pick up a $50,000 estate tax `bilL And if the property Is valued at other than agricultural values the tax btwdeii becomes even greater. Unless some changes ar~ made in the method of dealing with the estate tax law as it now applies to family farms especially since technology requirè~ Increas- ingly large amounts of capital. investment, we will continue to witness' a trend which could ultimately bring about the demise of the family farm structure as we now know it. There is an alternative to family farming, but it Is One we. do not like and we believe the Congress will like no better. It Is total corporate farming financed solely by outside capital. We do not believe the Congress prefers this type of farm ownership to the present family farm structure. Yet unless action is taken this will most likely occur. Fortunately, many members of `Oongress, as well as the President have come to recognize the problem. President Ford expressed concern about the situation in his State of the Unlon message and advanced ofle type of relief. We fully concur with his statement to the American Farm Bureau Fod~ration Convention in St. LouIs earls' this year when he said: "The continuity of our farm families is ~4tal. I want `this continuity preserved, so farms can he handed down gen- eration to generation, without the forced liquidation of family enterprises," The legislative branch `of government has shown `an equal interest. Numerous bills have been Introduced in the Senate to adjust the estate tax laws to main- tam the family farm. Here in the House the record is even more ImpressIve. A check of the Tanu- ary 14, 1976 Legislative `Calendar `Of your Ways and Means Committee shows three different categories under "Estate Taxes" which deal with "family farms", "rural property" or "real property which is `farmland, woodland, etc." We are pleased to note that under those three headings there are 09 bills which have been introduced by `206 authors from 46 states. Since then more blll,s have been Introduced on these subjects. These are hills directed specifically toward farm- ing and the list does not include bills dealing `with an increase in the basic exemption or the marital `dOduCtioñ-prOposalC which we also endorse' but which we have not listed `because they cover more than agriculture or rural area's. raorosnD nsTArrn rAx RflLIE~' MnASt~BES Most of the numerous es't~te tax proposal's which I have mentioned call' for one or more of the following changes `to the'estate ta~ law~ (1) valuation of farm- land and certain other lands `on the haste Of the "use" of the land rather than on the basis of "fair market vahle," (2) an increase In the $60,000 estate tax ex- eroption to some higher amount, (8) an Increase in the 50% matital deduction, and (4) a five-year deferral of estate tax liability' attributable ik~ family farms and small businesses followed by a 20-year Installment payment period at a 4% interest rate. This last proposal is the one `offered by the Pres&deu~ iu liis*State of the Union address. " ` ~` ` The various estate tax ±el'icf mMs~e~ being Droposed are not mutually ex- elusive and `there is' something to be said about the me~4ts o~! `each olie. In view of `this, we would hope that the Ooxtii~ltt~ë will adopt a `conibtnátton'of these proposed ehan~es. ~flowever, because our time is limited today, the emphasis of my' remarks will be directed toward tho'se proposals dealing directly with re- lief for family farms. vALT~ATToN O~' 13'ARMLANl) ON USa aA'ruER ~flAN rAfli MA KIST tALUS If there Is one measure which has almost universal support within the farm community it is the proposal to allow farmland to be valued on the basis of its use for farming purposes rather than vaiuatI~onon the basis of `fair market'value. ThIs is a type of relief proposed by Mr. Buviesen~s legislation (H.R. 1798 and other Identical hills) which at last count has 6~ co-sponisors. Under the Burieson bill, land must continue to be held and `used by the estate `beneficiaries as farm- land for at least five years following the death of the `decedent in order to qualify. PAGENO="0030" 16 The law sow r~qufres that property held at death, including farmland, must be included in the estate at fair market value. A large estate tax liability re- sulting from the valuation of farmland en the basis of its fair market value has caused in thu past and continues to cause severe financial problems for the surviving members of a famiIy~ rf~he5e pOopie are forced to sell all or part of the land in erder to meet the estate tax bill, or they are forced to abandon the use of the land for farming purposes and convert it to non~agricultural uses. 1k determining fair market value under the present law, a variety of factors are required to be considered including the highest and best `use of the property,. sales of nearby or similar land, the location of the land, the s1z~ of the land, and. other `similar facts and circumstances. This means that farmland situated near urban areas may be valued on the basis of its use as a residential `development or' maybe on itS use as `an Industrial park. This value can be many times greater than the value `of the land when use~L for farming since the rate of return on farm- land and other farm aSsests is generally much lower, than in the case of other' busine~s uses. By limiting the factors to be used in the valuation of farmland held by an estate to the use of the land for farming purposes, this clearly eliminates'inflated values. due to urban development or due to valuation on the basis of a more profitable use of the land. It Is noteworthy that 31 states already have laws allowing property tax valua- tions' of farmland to be made `on the bnsls of use of the land. Mr. Chairman, for the reasons I have discussed, we strougly urge the Corn- mittee to adopt a provision to allow alternative valuttlon of farmland based on it's use for farming. I~ this regard, it Is probably worth pcintlng out that the alternative valuation proposal involves a smaller drain on the Federal Treasury than the other estate tax proposals. According to Treasury Department estimates released by the Library of Congress, valuation of farmland based on use would. only reduce estate tax collection `by about $20 million `based on 1974 ievels,* xrwnz~sz THE $60,000 EXEMPTION Next, let me turu to the proposal to increase the curren't $60,000' estate tax: exemption. to some higher amount. Most sponsors have suggested a rise to $200,- 000 in order to fully take into account he rate of inflation since the $60,QQ~ exemption was enacted. Our organization has m~econunen4ed a $300,000 exe~p- tion. The President on the other hand recently called £Qr an increase to $150,000~ to be phased-in over a five-year period. flegardless of the figure, some substantial increase in the present exemption is clearly warranted, Because updating the exemption Is long overdue, we favor adjusting It immediately rather than pbas~ng it in over a period of years. I say this from the farmer's point of view because~ as mentioned earlier, the- amount of capital Invested by the average farm in such things as farm equip- ment, lh~estock, and other assets necessary f~r f~rrning has risen dramatically over recent years, The proposal to value farmland on the basis of farm use does not provide an~r estate tax relief for the substantially higher value of farm prop-~ erty other than land. And, we believe this proble~i should also be dealt with. If farm equipment or other essential assets. have to ~e sold to pay estate taxes, the- effect is the same as having to sell or eo~vert the farmland itself. If the Committee finds that from a b~~Igetary stapdpoist it Is not possible .to increase tl~e exemption across the board by an amount large enough to solve the problem c~nsed by t~he higher values of farm equlpme~t asd other non-real property, there Is another way to treat the problem. Thl~s alternative would, allow an additional exemption for the first $200,000 of the valpe of a family farm. This is an exemption iii addition to the basic $60,000 exemption. If the Committee raises the $60,000 exemption for all taxpayers, the additional $200,000~ exemption, for family farms could be lowered accordingly. As you are no doubt aware, the Senate in 1974 adopted an additional $200,000 exemption for family farms, Mit no action wan taken on the measure in the House. Before turning to the next proposal, let me make It clear that we are suggest. Ing an increase in'the exemption ip addition to valuation of farmland based on. nse-liot In lieu of this latter proposal. *`~Ana1ysis of llstate and `Gift Tax Proposals Introduced in the Senate In 1975," Con- gressional necord, January 23, 1976, p. S-435. PAGENO="0031" :17 ~E~EAE ~F~E~RM~ ~OLIÔ%~DB~ 2~ ~EiathStALtMEW~ PAt~{~t~T O~ ES~ArE~AxES Next, ~ would like to brl~~y ~ pi~oposal to allQw a five-year moratorium o~i ~tate~ `ttt~ liabflft~ attributable to ~fathii~v farms or small businesses ~llowe4 b~ a 2O~.year tn~tailment pa~ment~etiod at an i~nte*' est~ rtite of 4~ ~rathért~n the cm~rent 7% rate. A~ with other p~po~als, th&s wouhi be quite helpful to many farmers., i~swever, W~ ~LQ not~ believe standing alone it prOvides sufficient relief. Consequently, It necessai~iI~ must b~ coupled with some or all of the other proposals. In addition, tthe~e are some technical problems with the proposal which we will be happy to discuss with the CQmmitbee staff. INCRSASE T~ `50 ~EcuNr MARrrAL ~VCTIOf~ Others will no doubt discuss in great detail an increase in the~O% marital ~1ednction. For that ~ I will limit my comments by sta~iug that snc1~ ~n ine~ease wOuld obviously be hel1~ful to everyone-farmers iaclnded-~--frOm at least two standpoints. It could eliminate estate taxes on the farm property aeft the snr~tv~ing spouse and could alSo eliminate the complicatec~ and often expensive estate planning now required to iin~$z~ taxes on the estate of the ilrst spouse to die, CAPIT~L GAfl~S TAX OI~ rt~O]?E5~T H1~LO AP b5ATI~ * I3bially, we want the Ooiximittee record to clearly show' that ou~ group opposes a capit~d gains tax on appreciated property held at death. The effeet of l~upo~iug such a ~ wo~sld be to recreate iiio~t, if not all, of the estate tax problems which iou are So diligently trying to solve tlr~ong'b the various con- structure provisions being considered. In the case of farmers, the farmland held at death. has often appre~Mte4 greatly oyer the cost when origin~ily pu~c1rased or When inherited. .& large `capital gains tax on this appreciati~h would again force the sale of the land in order to meet the tax liabffit~~. tn closing, I would like the Committee to know that by commenting on the * problems of farmers, wedo not mean to imply there are not zu~ny other citizens who encounter serious ~roblews because of the present estate `tax law. We realize that you must deat With the probIem~ of the farmer within the context of small business owPers and other taxpayers, and al~o with1~l 1*tElgetary r~ie- tloni Non~theless, within this eout~t, we hope that the Committee understands the pligh~ Of the ~a~rmer when considering' estate tax e~anges. We urge you to adopt relief provisions along the lines suggested. Thank you again for allowjng me to present our view~s.. The C~i~u m~s. Thank y,~u very mnelt, Mr. Wo~dw~trd; We will next hear from :M~rs. B~rool~shire, the Wemen's Auxiliary, Associated Milk Frodueexs., * * - * * SENT O~ 3AB~B4R~ B~O~SBXB~ Mrs. BRooKsaTm~. I welcome this opp~rtuuity, M~e. ;Cbairm~n, to *appe~r on behalf oct the 19,000 dairy farm wives represented ixi t~e Associated Milk Producers of the micistates region ~iu supj?ort of proposals favoring th~ Federal estate and gift ~orrtis. The Associt~cted Milk Prodttcers are all family t3'~pe c~aciry. ophra.- tion~, banding tqgether for .bette~r bargaining and servk,~ tG its.-rnexn~ bers. I am a da4ry farm ~ife and partner and have worked in this :~aPatht~Y fcir 28 y~arS~' * ` * The CHAnU~IA~. Let me br~ak in by saying that your tetioz~y~n~ be the most impor1~nt of ~l tod7ay ~because the ,-farw ,b seWi~e i~the one who bears a' great deal. `of the burdem of thes~ de~i~ions. ~We `especially value your testimony. You may proceed. Mrs. BR00K5rnRE. We appreciate the fact that you do recognize this, Mr. Chairman, and we trust that the committee does the same. PAGENO="0032" 18 Our operation is located in Putnam~County, mci., where we are marketing over a million pounds of milk annually for the grade A Indianapolis market. I am accompanied here today, Mr. Chairman, by three of our officers, Mrs. Glenn Thronson of Blue Mounds, Wis.; Mrs. Verb DeWall of Shannon, Ill.; and Mrs. Harold Rawles of Albion, md., whom I would like to present to you at this time. They are seated behind me. The CHAIRMAN. We are very happy to have you all. Mrs. BROOKSHIRE. They are all dairy wives with families who are interested in continuing the family business. Although our tax thinking is directed to the small family-type farm, let us remember that we are no longer thinking of `a few acres, a. few cows, and perhaps a tractor or two, To remain in farming today is big business,, agribusiness, if you will, where an average farm of well-managed `dairyland can generate $100,000 into our total economy producing tons of food for our Nation. The love of the land and the ability to make it return profitably is not something acquired, but is rather an inborn characteristic that must be recognized, encouraged, and promoted. While milking the family cow was once relegated to the role of the housewife, today the dairy wife is probably a college-educated woman who works beside her husband in management as well as in the total operation. She is not building social security credits toward her future retirement; she has probably given up the opportunity of a regular paycheck with extended benefits to stay home and work with her husband in building their own business. Should she then be taxed for inheriting quite possibly what might not have, been were it not for her years of diligent devotion? While the $60,000 exemption enabled a farmer or small business owner of 1942 to paSs on to his heirs a home, an automobile, and a substantial part of his business, but the $60,000 today can be absorbed in one small corner of the farm, perhaps only the home. Within this past year a neighbor of ours installed a new milking parlor system at ~ cost of $80,000, which cost did not include the necessary bulk milk tank, silos~ or any of the related areas. Our present exemption would not cover this one phase of his family operation, to say nothing of the land values, the livestock, or the many pieces of equipment pertinent to his operation. As Senator Gaylord Nelson reported in his December release, "In- flation has increased the value of business and farm assets over 24 percent since Congress enacted the $60.000in 1942." In our area band values alone have increased 250 percent in the last S ye~rs. It has l'bn~ been recognized that Americans spend the smallest per- centage of their income to feed their families of any place in the world, and this is directly related to the program of efficiency found on the fafflily farm. There are less than 300,000 dairymen in America today providing an adequate `supply of fresh milk and dairy products for 214 million PAGENO="0033" 19 Americans. Private enterprise, the found'a~tion~f our society, not only produces cheap food for our table, but produce's outstanding young Americans who are becoming the leaders of tomorrow. One of the goals of the auxiliary which we represent is that we shall work to improve the present and future of dairying. lit is our strong belief that our children shall have the op~ortuni'ty to farm if they so desire, to continue in dairying if it be their `choice, for only those who have grown with the program will have the fortitude and stamina to enter such a lifetime of devotion. Unfortunately, at the present time, estate tax laws run in the oppo- site direction, forcing liquidation of farms, reduction of acreage, or subservience to .a lifetime of taxation. President Ford has expressed concern over the impact of the estate tax laws on farmers-and `we are grateful that Members of Congress are equally concerned for those who are `working our family farms-I am well `aware that 55 `bills have been introduced during `this election year, but the suggestion of delay- ing `and extending the payments over years leaves cold chills rather warm feelings. Let's get to the root of the problem, the hidden tax hikes created by inflation. This `is the area that the farm family has to manage. My husband is currently executor for the `settlement of his father's estate, so we are personally involved in the effects of these tax laws. Our present gift tax laws prevent transferring more than a small acreage at today's inflated prices, hardly enough to cover the land itself, to say nothing of the improvements thereon, yet we wish, `to continue our dairy operation into the fourth generation, for it is `a good way of life and the farm `is equipped to serve as `a dairy. Shall we sell the farm or shall we pass on a lifetime of debts to the grandsons? If we are `to improve the future o'f dairying and of farming, this committee must find a realistic way of alleviating these tax burdens, thu's providing `a stronger portion of the continuing operation. Fewer than 2 percent of all tax `dollars come from estate taxes-~ is it not better to keep food on our tables and t~ economize elsewhere? It is presently an utter impos~ibUity for' a young `marvto enter into farming for less than $100,000. Would' it not be `better to have him continue `a family opcrwti'on rather than turn to a government subsidy as is done in many countries? Therefore I urge your comimittee to take immediate action to make every effort possible toward the continua- tion of the family farms that we may continue in our stewarcl~hip of the land. Than'k you, Mr. `Chairman and members of the committee, for this opportunity to appear. We will be happy to try to answer any ques- tions, if you so desire. The CHAIR~IAN. Mrs. Brook~hirc, you have been very articulate and very eloquent. Our next witness this morning is Mr. Albert E. Geiss, International Association of Ice Cream Manufacturers from the Milk Industry Foundation. Mr. Geiss, welcome to the committee. 68-872-76-3 PAGENO="0034" 20 STATEMENT OP ALBERT E. GEISS Mr. GEIss. Thank you, Mr. Chairman. Mr. Chairman and members of the committee, I `appreciate this opportunity to appear before you this morning on a subject which seriously involves my company and two national industries which I represent. I am president of the Barber Pure Milk Co., Birmingham, Ala., a family-owned `dairy. I am `also president of the Milk Industry Founda- tion, located at 910 17th Street NW., Washington, D.C., and I `speak for its members who are located in every State of the Union. The com- panies belonging to this organization are the bottlers of fluid milk and processors of fluid milk products. Additionally, inasmuch as we were `asked to consolidate our `testi- mony. I am speaking for Mr. J. Lloyd Langdon, president of the International Associ'Ction of Ice Cream M'anufacthrers, located in the Barr Building, Washington, D.C., an'd the rnen~bers of that organiza- tion. `This association also has members in every State of the Union, producing ice cream `and related `frozen `products. Together, the asso- ciations represent companies which operate approximately 2,000 dairy processing and manufacturing plants. `To emphasize the fact that these industries are characterized by small family-owned enterprises, I would like to point out that accord- ing to a recent U.S. Department of Agriculture publication, 75 percent of the plants were operated by local companies which owned only one plant. Moreover, 50 percent of the fluid milk processed `an'd `bottled in the United States today passes through local dairies operating `but one plant. The two organizations specifically want to focus attention on badly neede'd changes in our present estate tax provisions. We are aware of the many `bill's that have been introduced `and referred to this `committee `an'd `of the similar legislation in the Senate. It i's our understanding that `although `we are ~commen'ting primarily on H.R. 11770, introduced by Congressman Burleson, this hearing is really an overview. ` ` We have read President Ford's rëcomrnendation~ `presented March 5 in Springfield, Ill. `We support his ideas even, though all the details of the legislative proposal have `not yet `been transmitted to this committee or to the Senate Finahce Committee. We know some of the present bills relate only to revising estate taxation of farms, which `we support. H'o~~eveF, ih the President's statement of March 5, `an'd in his earlier proposal at the beginning of 1976, it seems clear he intended not only to include farm's, but also businesses and `individual's. He speaks of, and I quote: "To ease the burden~of estate taxes on the many Ameri~ cans with modest estates * * ~ I am sure that `agricultural organizations `will speak to the problem of farmers `and farm families. However, the burden of this tax is now most onerous, not only for farmers, `but for businessmen `an'd `all Amer- icans w'ho work and save. The farmer, with taxed dollars, has had to purchase real and per- sonal property in order to maintain his enterprise. With the value of PAGENO="0035" 21 the dollar constantly eroding, it is surprising that no prior effort has been made to ease the estate tax burden. In fact, several decades have passed with little change. Senator Gaylord Nelson of Wisconsin has made a further point that since the $60,000 exemption was enacted in 1942, inflation has increased the value of business and farm assets about 224 percent, making this tax burden confiscatory. All of you are aware of the appreciation in the value of individual housing, thus creating an ever-greater hardship for the family survivors. Senator Nelson also remarked that the income tax exemptions have been increased several times by the Congress to a total of 50 percent. But the estate tax exemption has not bee touched. To further drive home the adverse effect of the estate tax, he has been quoted as saying: "While the $60,000 exemption enabled a farmer or business owner in 1942 to pass along to his heirs a home, automobile and a substantial part of his business, the $60,000 can be absorbed today by the family residence alone." The change that occurred within the last 2 years has made the burden of these estate tax payments more difficult to bear even with 10 years to amortize the obligation to the Treasury. Originally we paid, and I speak from experience in my own com- pany, 4 percent interest. Then, it jumped to 9 percent on July 1, 1975, with the passage of Public Law 93-625, and was reduced to 7 percent February 1. This is still a considerable increase and further erodes the financial position of those paying estate taxes. The increase itself is a very substantial burden, but the u~ioertainty compounds the problem even further~ Most family-owned milk and ice cream companies have no way of obtaining needed ëapital invest- ment except b~ earnings or by debt financing, and much of it by debt capital. Thetince~tninty ~f a changing rate of payment of estate tax interest greatly cô~nplicates the firm~s ability to obtain capital from its normal financial ie~ading~ institutes. As with the farmers, the dairy products businesses, and particularl3r those family-o~vned enterprises, h'a~e purchased, with fully~taxed ~lOl- lars, the bricks and mortar for their buildings and equipment needed to process and package their extensive line of dairy4~rbducts. AdditiOnally, th~y have purchased large fleeth of rdlling stock for deli~ering these p~rishai~le c~thniodities to stores, homes, hotels, restaurantshiid other diftlets~ Becaus~ the daii~y in~istcry is a ~r~ry low margin industry3 the retained ftI'tth~gs ar~ sm~ili and even the 10-year athortization period is difficult 1k~ it~et. The estate tax burden Is often equivüent to repur~ chasingthe fan~ily fa~m, or ~iome~or bnsiness. W~ haveea~me situations *her~ t~he ~state th~ con~titntes well over 50 p~rcent of the company's net worth. S Again. I speak from ~iersofial experience with my company when using that percent~ge figure. I kn~iv from my own certain kfiowledge 6fat:1ea~t 13 dire~tors of ~ asso~iations who are strñgglingiinder the activity liquidated by the tax load placed on the family members at- tempting to continue the business and pass it on to future generations. I know there are many more dairy companies prospectively fa~ihg PAGENO="0036" 22 this problem. I do know of many small companies, family enterprises, which have gone out of business. Some have closed their doors because they could not hope to raise the cash to pay these taxes. There are a host of family dairy plants now for sale because they do not have the resources to face this kind of tax burden, to allow their sons and daughters~ to carry on the business with sufficient capital to make sure it is a viable operation. I point out at this juncture that there has been an average decline in the number of fluid milk processing plants at the rate of 6 percent a year since 1969. Estate tax problems are probably a major reason for this decrease in plant number. The exemption of $60,000 is still creating a hardship for the in- dividual, who has worked all of his life and with fully taxed dollars, has purchased a home, personal property, and made what investments he could prudently make in order that his survivors would not have to sell their homes and sacrifice other assets to meet their estate tax obligations. Most of the bills we have examined propose increasing the present $60~000 estate tax exemption in amounts up to $200,000. We think this is very modest in view of what has happened to the economy. Cer- tainly it is obvious that the $60,000 exemption is not realistic in terms of the present values of the farm plants, small businesses, and the estates of the average working American who has been frugal in trying to take care of his or her family survivors. We, therefore, hope that you will consider increasing the exemption to at least $200,000 as a minimum. We support the idea of a tax moratorium for some reasonable pe- riod after death in order that the heirs of the farmers, the business- men, or individuals could so arrange finances that they could then pick up the burden of the estate taxes over a period of years. In this connection we urge that instead of the present 10-year pay- out period, we follow the initial proposal of the President, that there be a 5-year moratorium after death, and a period of 20 years with greatly reduced interest rates allowed to amortize the obligation to the U.S. Treasury. We would hope that the interest rates would be permanently stabi- ized so we would not have a repetition of the rate changes which occurred in 1975. It has long been the philosophy of our Government to encourage family farms, to help make viable the small and family businesses, and to make sure that the hardworking, thrifty people could retain and pass along most of the fruits of their own labor. One of the most constructive ways that I know to reach these three important objectives would be to make these changes in the estate tax program effective as soon as possible. Mr. Chairman, members of the committee, I thank you for your attention. I will be happy to answer any questions with this dis- claimer. I am not a tax specialist. I am a businessman who has ex- perienced firsthand the problems generated by our obsolete handling of estate tax problems-~--estate problems that can lall upon a family- owned business. Thank you for your attention. The CHAIRMAN. Thank you, Mr. Geiss. PAGENO="0037" 23 Mr. CRISwELL. We have Mr. W. B. Cri~well~ Plains Cotton Growers Association. Welcome to the committee, sir. STAT]~MENT 0]? W. B. CRISWELL Mr. ~ISWELL. Thank you, Mr. Chairman. I am a cottofi and grain farmer of Idalou,on the Texas, high plains. I am currently serving as the elected president of Plains Cotton Growers, Inc., our cotton producer organization on the plains, and it is on the authority of that organization's board of directors and on behalf of its 23,000 members that I speak today. I very much appreciate the lead taken by this committee in seeking a solution to the grave problems arisino' out of the F~deral estate tax, and I appreciate your taking time to `ear the vie~s of high plains farmers in that regard. I know your time is limited and I will be brief. It is my understanding that estate taxes, or death taxes, originated in our societies as a means to lessen or prevent the bad economic ~f- fects of a few people gaining an inordinate amount of wealth, prop- erty, and power in those societies. And there's much to be said for that objective, especially where agriculture is concerned, in our own society. But the estate tax law in this country in recent years has been having the exact opposite effect. The estate tax has become so burdensome that heirs to farm opera- tions, operations barely adequate to support a family, arc being forced to sell their land because they encounter extreme difficulty in obtaining funds to pay the tax. And the primary buyers for these estates are large corporations or others who already hold title to wealth and power far greater thax~ that of the deceased or his heirs. As these farm ei*erprises go on the auction `blOck, thp dcatih tax becomes a death-dealing tax as well, bringing about the demise of hundreds or maybe t:housands of family farms every year. There ~re several reasons why this tax has become s~ unbearably oppressive in recent years, not `the least of which is the economic waves caused `by inflation. The market price of farmland since the $60,000 exemption was set in 1942 has bailoone4 by at least 600 percent. Irrigated f'a5rñiland in my community in 1942 sold at $100 an acre and less, while the same land today can't be touched for less than $600 an acre. Unfortunately, however, this does not mean that the true value of this land-the value in terms of its ability to produce income in con s'tant dollars-has grown by 600 percent. It means instead that cor- porations, professional nonfarm people, and others among the wealthy, for speculative or inflation-hedging reasons, have bid the market price far above What it is worth to the man who hopes to support a family on what the land will produce. Attached to my statement for the use of the committee is an example which I believe is typical of what has happened on the Texas high. plains and will happen again and again unless the tax law is changed. This example, as you can see, is based on the thx as applied to husband-and-wife ownership in a community property State such as rfexas It assumes 960 acres, which is close to the minimum size needed PAGENO="0038" 24 for efficiency on a high plains irrigated farm. This land is valued at a minimum $600 per acre, and that value alone, excluding the value of improvements and farming equipment, has been used in the tax liability calculation. Example 1 shows the tax due upon the death of either spous&- $59,100; and the tax due after the death of both spouses-$118,200- under the best of circumstances. Example 2 reflects the Federal estate tax due after both deaths_$191,008~~_if the farmer does not avail himseFE of sophisticated tax coui~sei. In any event, $118,~00 and $191,008 is ~a subs1~antial part of the estate's original $576,000 valua- tion. While a 10-year payout of the Federal estate tax would be available, this does not red~ice the amount of the tax burden. Also, we are aware that a new income tax basis-cost-is available and would amount to $600 per acre. However, this is of little value to the family who desires to continue the farming operation and has no plans to sell the land. We understand consideration is being given to coupling the Federal estate tax with a capital gains tax at death, which we believe would make the total taxload truly disastrous. I think you c~n se~ from this example that there is a strong case, and a great need, for revising the estate tax law. Without revision, the family farm enterprise, within one or two more generations, ~viul be a thing of the past. The production of all our Nation's food and fiber~ will be done by a few corporate-type operations, to the detriment of our entire society. I have addressed myself here only to the estate tax as it affects fi~rm- ing enterprises. That is because-and only because-farming is the business with which I am most famjliar. It does not mean that we in agriculture are not aware that other family-size busin~sses are faced with some of the same problems and are just as direly in need of relief. Increasing the Federal estate tax exemption from $60,000 to $200,000, plus providing for the valuation of farm estate on produdtive capacity instead of inflated market value, as Congressman Burleson's bill would do, coupled with the defeat of any proposed legislation that would impose ~. capital gains tax at death, appears to be the minimum adtion requiTed to alleviate the problem we have outlined. We respebtfully urge that this cornm~ttee given full consideration to our views, and we offer any service that we may be able to render in the effort to correct the inequities that exist in the current Federal estate tax law. Thank you very much. [The material referred to follows:] ESTATEPLANNING ENAMPLES Introduction `Uex'as is a commupity property state, meaning essentially that all wealth ac- cumulated by a married couple during their marriage belongs on&half to the husband and one-half to the wife, The gross estate of an individual is subject to certain deductions in add~tlon to the current $60,000 exemption. Among the deductible items are estate ad- ministration expenseS, funeral expenses, debts, credits for state inheritance taxes, PAGENO="0039" 25 and charitable gifts. ~Uhe fo1lowing~ eza1uples assume~that these deductions are offset by the value of land improvements and farm equipment, leaving laud value as the net estate value. Community Each spouse's property interest Example 1, (Assumes estate of first expiring spou~e is left to other than surviving spouse): Assume a married couple with community property valued at $576 000 (960 acres at $600) $576, 000 $288, 000 If one dies, Federal exemption is 60, 000 Leaving net taxable estate of 228, 000 With a Federal estate tax liability of 59, 100 Tax liability at death of surviving spouse. 59, 100 Total Federal estate tax 118, 200 Example 2. (Assumes first expiring spouse leaves pstateto surviving spouse): Original part of the community property 288, 000 Inheritance ($288,000 minus $59,100) 228, 900 Total estate upon death assuming no increase or decrease in value 516, 900 Federal exemption 60,000 Net taxable estate 456, 900 Federal estate tax liability 131, 908 Total tax cost of transfer betweengenerations ($59~l00 plus $131~908) ~_. 191, 008 The CHAIRMAN. Thank you very mu~i. That concludes all of the statements ttnd, without objection, they will appear in full in the record, together with the supplemental mate- rials that you hä~ve supplied. You have certainly given us ~ioquent tes1~imony on the need for ac- tion in the field of estate and gift takes. Don, tell me in the area where you live, with which I am, of course, quite familiar, what has been the change i~ valuation in land in~ the last 30 years? Mr. WOODWARD. Land in the last 30 years in the area where I partic-~ ularly farm has gone from around $200 or $250 äi~ acre to sQme which has been ~oid recently for $700 an acre. The CHAIRMAN. So it has been almost a three4old increase. Mr. WO0DWARD. And there are instances in other areas where the land might be a little lighter and ~[ remember I had a ôhaiice to buy some land somedistance froifrffiy place i~or arOund $25 anacre some 30 years ago and that land is ~elling~ fo~r Over $200 an acre. So that the lighter land has i~icreased in v~lue e~~en more. The CHAIRMAN. Even more, and a lot of that ligbter land has been very productive. Mr. WO0DWARD. Very productive because of fertilizer and tI~is type of thing. The CHAIRMAN. Better farming practices? Mr. WOODWARD. Yes~ The C~EIAIRMAN. So that half of our countr~y usedto be marginal and now it is very productive year after year. Mr. WOODWARD. My father sold a rar~ch bec~use it wa~n't productive about that time and since that time theland has become quite produc- tive so that he made a mistake. The CHAIRMAN. That is true. That is a tremendous increase in valuation. Your kind of farming is nOt affected as thuch by some of the recreational investments but I know cattle ranches have in many PAGENO="0040" 26 instances gone up even more in value because of tremendous pressure from outside buyers coming in buying a way of life. Mr. WOODWARD. I have a son-in-law who is in the real estate business in a cattle country and he even hates to sell the land for what he can get for it because it seems so outvaiued with people coming into that area to have mountain homes, hunting lodges and this type of thing, and this takes that land away from the cattlemen at exhorbitant prices. The CHAIRMAN. I have a friend who has a ranch down in Klamath County who I am sure could sell his ranch for $2 million. Yet he is having a hard time making a living on it. Mr. WOODWARD. That is definitely true. The CHAIRMAN. That puts a tremendous burden. He wants to hold it. He doesn't want to exploit it. He is a conservationist at heart. It becomes a tremendous problem as to what happens when he dies and they put that valuation on it. The taxes will be almost impossible to raise. Mr. Schneebeli. Mr. SCHNEEBELI. Thank you, Mr. Chairman. Mr. Grant, there seems to be a new push on the part of the farmers relative to estate and gift taxes. Have there been many instances re- cently that you are aware of where farms have had to be sold because of the enormous estate and gift taxes or is this just becoming now a big problem in the farming industry? Mr. GRANT. Of course the rapid escalation of inflation over the last couple of years has intensified the situation but it has been a situation for a long period of time. I know of two brothers who were running a dairy with their father. The father died. They had not made adequate preparation and they sold the land and dairy to pay the inheritance tax. Mr. SCHNEEBELI. But it has reached the acute stage in the last couple of years. Mr. GRANT. Yes; and the Farm Bureau had held seven multi-State meetings in the recent past and the first priority of the 2,000 people attending these multi-State meetings was the reform of estate tax laws. Mr. SCHNEEBELI. I am aware of that because I had dinner last week with the Pennsylvania Farmers Association. There seems to me to be a new push on the part of the farmers particularly and I wonder whether 3 or 4 years ago it wasn't as prominent an issue as it is at the present time. Apparently it has not been because this is the first that our corn- mittee has heard of all of this-of this increasing demand for action. I am glad the chairman is taking this action. Mr. GRANT. It was an issue. Mr. SOITNEEBELI. But it was dormant, wasn't it? Mr. GRANT. The chairman of the committee has taken an interest in this and Mr. Burleson has taken an interest in this and about 100 other Congressmen have taken an interest and this gives some hope to farmers that there may be somethim~ done. It seems incomprehensible that just because a woman's husband dies she has to give up the farm. Mr. SCHNEEBELI. I think other groups support you, too. Mr. GRANT. We ought to remember that this is not only a farm bill. PAGENO="0041" 27 The first two issues have to do with estates that are not farms as well as farms and the third point does have value to those people living in the city. Mr. SOHNEEBELI. Yes. Thank you very much. The CHAIRMAN. Mr. Landrum. Mr. LANDRTJM. Mr. Chairman, I think in all the experience that I have had as a member of this committee over the several years that I have `been privileged to be a member, I have not heard a more construc- tive panel address itself to a more pressing problem than that which we have heard this morning. Many of us could relate personal experiences, I am sure, that would emphasize what this ]ady and these gentlemen have said to us about the need to revise the estate and gift tax laws. I can tell you at the out- set that I had forgotten about the hearing until Mrs. Landrum picked up the paper this morning and saw the schedule listed in the Washing- ton Post and said, "What is your committee doing today," and I said, "Oh, I had forgotten that we are launching the hearings on estate and gift taxes." She said, "Get over there and don't be late. I don't want to be pushed out of what I have helped produce here if you predecease me." Another personal experience that I was thinking while Mrs. Brook- shire was so articulately explaining what is involved in operating a family dairy of an experience I had durin~ my college days when I went out to the wheat harvest in Kansas and Oklahoma to pick up a little extra money and some experience, too. Most of what I got was experience. I went into the wheat harvest and found that wheat was bringing 26 cents a bushel and the wheat farmers didn't give a damn whether they harvested it or not. One said, "Come on out and live with me and I will let you help my wife with the family dairy and you can play baseball for me twice a week." I had a reasonably good college reputation as a baseball player. So I took him up. I was helping this lady in Newton, Kans., Mrs. Keys. I was helping this lady in her family dairy operation where we milked the cows and put the 5 gallons out on the highway for them to pick up. I don't know whether you use them now or not but back in those days they used what we call kickers that were put on the hocks of the cows to keep the one next to you from kicking you over and the one you were milking from kicking you. You were milking with your hands. I had the cow next tome and the cow I was milking hocked into the kickers and they got to moving and kicked me over and got their feet on my chest. It was a rather brutal- izing experience but they left enough wind in my lungs and enough space in my face for me to talk and produce some rather loud conversa- tion. I heard this lady coming say, "Please be quiet. Don't say that any more. I will get to you as soon as I can." She came and got me relieved from the pressures of the cows feet off my chest and some of the other things that I got removed after it was over. Then I came to Congress about almost 30 years after that and one of the earliest notes I received was from that dear lady and it said, "If you are as successful in telling your colleagues how you feel as you were in letting those cows know how you felt, you won't have any trouble getting along." PAGENO="0042" 28 I know it is not good on Monday to bring up things with such levity when we are dealing with such serious problems but we are dealing with the very heartland of America and I hope this committee, whether I am here long enough or not, will meet this problem by rais- ing this estate tax exemption to at least $200,000. It ought to be a quarter of a million dollars. Thank you, Mr. Chairman. The CHAIRMAN. One of the leading sponsors of this legislation in this field, Mr. Burleson. Mr. BURLESON. Thank you very much, Mr. Chairman. I certainly join with ñ~r colleague from Georgia in expressing my appreciation of what this panel has said. It is quite natural that I agree with all that has been said. When someone agrees with you, you know, you think it is good. There has been an emphasis by all of you that this is not limited sim- ply to agriculture and the rural areas. This is a thing that we hope to impress on our colleagues from the urban areas, that it is important to them. It is important of course to the Nation that we have an ade- quate supply of food and fiber and it is being done with the most ef- ficient operation in the history of any nation, ours included, at the cheapest price. Mrs. Brookshire, you mentioned about this coming to be a philo- sophical question in what you said about the young man going into an agricultural operation with a minimum of $100,000. If a young man had $100,000 to go into a minimium operation of whatever commodity, whether it be dairying or cotton or grain or something else, I would imagine that he would go to the bank and buy CD's or to `the savings and loan where he wouldn't have to depend on the elements. If we break up family farms, our younger people are going to the cities to compound `problems which are `already insoluble in many respects. Mr. Grant, you probably know this better than I, but something sticks in my mind that a few years ago, just 3 or 4 years ago, the aver- age age of the farmer was about 56 years. I believe that has dropped a little maybe to 54, or something. That is encouraging and will be more encouraging if we give the incentive for our younger people to stay on the farm and produce, where it has become a sort of cliche that the agricultural small farm is the backbone of America. It is in numerous ways. YOu know that. The estate and gift tax was never intei~ided, as I understand, to raise revenue.' We are going to hear a lot about this in the course of these hearings. That was never intended. It really was intended to provide for the distribution of the wealth. So it seems to me that it is time to turn this thing around, and you have given us the answers here that this affects all Americans, and we have to realize that somebody has to produce. We can't all be receivers the largesse of government. Somebody has to produce. You are the people who raise food and fiber for those who buy at a'reasonably cheap price as compared to all these other nec- essities of life. We have to help in buying a $2~,000 tr~actor or disk harrow~ or what- ever it is for those ~people who make it, for the wage earner who makes it in Illinois, Ohio, Pennsylvania, and a lot of other places. This is our system: PAGENO="0043" 29 I don't have a specific question except just to comnientiacre that you have covered this subject th~roughl~ and from the anost reasonable standpoint fnrnishing supportive rationale on why we must do some- thing ~bout this estate and gift tax problem, or we are simply gOing to destroy the source of production in this country. Thank you very much. The CHAIRMAN. Thank you, Mr. Burleson. Mr. Conable. Mr. CONABLE. Thank you, Mr. Chairman. Mr. Grant, iwañt to talk to you particularly. I have a lot of respect for the Farm ~ureau and always have had. I grew up ion the firm and my brother is still on the family farm. There has been an air of euphoria here this morntng. Everybody is agreeing with you. I want to talic about some realities and get ~ome realistic responses from you about what we are talking about here. We are talking about increasing the exemption t4~ $200,000. That would cost the Government $2 billion in revenue, or almost half the total amount raised from the estate tax. Farmers would be the primary beneficiaries and farmers have a special problem becauseof their lack of liquidity. I know what the difficulty is when you are in~a cost squeeze relying yourself on a real market and buying the things you need to run a farm in an administered market to a substantial degree. Costs have gone up over a period of time and your margins have gone down inevitably. Now I personally think the farm community has made a mistake in pushing this Congress for a solution because this is a very liberal Con- gress and it is inconceivable to me that they are going to give $2 bil- lion to people with estates over $100,000. Maybe they are but that is not my view of this Congress. Everybody has be~n talking about re- forming the estate tax. In fact, you are asking fOr a reduction of estate tax. Reform usually means that what you take in apples you give back in oranges, and vice versa, and this committee ha~ traditionally ap- proached problems of tax reform with an eye to revenue neutrality. It is my view that farmers would be considerably ~orse of~ ~e~ing taxed on capital gains at death than they would leaving the exemptiou where it is. What do you think about that, sir? Mr. G~RANT. Certainly if capital gains are taxed in the bna~nner that you express then it might be a problem, but we are hoping that there will be recognition of the fact that there is a necessity ~o pass on the property to the heir whether it is farm. property or city property. Mr. CONABLE. I suspect the carrying over of the base~ before death would create very serious problems for farming also. Revaluation ~t death has been a very important part of sweeping the slate clean and putting the new owner of the farm after an estate proceeding in a posi- tion where he will have a more realistic valuation of his place. I am very much concerned about possible moves in this direction because I don't see this Congress giving $2 billion to peolie with sub~ staiatial estates even though they mayhave problems of liquidity. I wish you would be thinking of what sort of t~aing we can do to reduce the revenue loss to the Treasury, without doing violence to the farmers' need somehow to finance this kind of a contribution to Uncle Sam, that is, admittedly, very burdensome to him. Mr. LANDRUM. Will my friend from New York yield. PAGENO="0044" 30 Mr. CONABLE. Yes, I yield. Mr. LANDRUM. I am disturbed about the statement that we are giv- ing the farmers or giving people with estates of $100,000 or more $2 billion of Federal revenues. We aren't. We are not giving anything to anybody. We are just trying to find some means, my friend, of allow- ing the farmer, or dairyman, a chance to keep what he has. We are not giving him anything. This type. taxation developed and has been used several times in our history, before World War II, as only a temporary tax, and since World War II, as I know my friend understands it, has been kept on the books permanently, and now brings in abOut $6 billion a year. That is what its toal fund is. Mr. CONABLE. $4.7 `billion. Mr. LANDRtTM. The information given me last week was $6 billion, approximately. We are not giving anybody anything. They are keep- ing what they have. Mr. CONABLE. I understand the point the gentleman is making. Tax expenditures, if they are remitted, are not gifts. The Government obvi- ously is not a beneficent force when it is collecting money from people. I understand the point he is making and I agree with it as I well understand, however, in giving up revenue we have to make choices and I am simply judging that this Congress is not likely voluntarily, or it is not likely at least without a major phase in, to simply abandon $2 billion of revenue it now gets from estates. if you are looking at this from a reform viewpoint, that means revenue neutrality, and the question is, where can we pick it up. I want to tell you, Mr. Grant, that I am going to try to help you on this, and I am talking realistically only because I find there is really an undue euphoria in the farm community about the fact that you have something going at this point. I realize that it has been delayed a long time. Do you have anything further to say about that, sir? Mr. GRANT. Congressman Conable, we do have every intention of influencing this Congress, which you have a better appraisal of than I, certainly, `but we have every intention of influencing these Congress- men this year, and we `have started on the program of doing just that. We intend to do it clear across the Nation. As Congressman Landrum has said, this is not a gift to farmers or to those owning other property, it is only 2½ percent of the total budget, and therefore, we think it is small enough that for the con- tinuance of agriculture and the handing down of one piece of property to another, whether it is agriculture or not, is worthwhile. Mr. CONABIAE. Coiigressman Landrum made a good point. No tax remission is a gift. It simply means that we don't take that much away from then on. That is a point on which I would agree with him com- pletely. Mr. GRANT. I have three sons, and Congressman Burleson men- tioned the fact of the age of farmers a few years ago. My two eldest sons decided they didn't want to bother with farming because they didn't see how the farm could be passed on. The youngest son is still in college and he thinks there is a possibility that he may be able to farm the present farm and is therefore interested in agricul- ture and taking courses in agriculture. PAGENO="0045" 31 I think we need these young people on farms and. I think it i~ a broader problem than perhaps we have appraised it as we have given our testimony. Mr. CONABLE. I personally think farmers have a special estate tax problem generally, although admittedly some small businessmen too have problems in valuation and liquidity. Therefore, I would hope that the farm community would think of ways in which they can be aided in this particular respect without the revenue loss which I am very doubtful this Congress will countenance, whatever the friendly individual attitudes of the members of this committee. Mr. SCHNEEBELI. Will the gentleman yield. Mr. CONABLE. I yield. Mr. SCHNEEBELI. I would like to correct some figures1 The $4:.7 bil- lion is less than 1.5 percent of our Federal revenues. Our Federal rev- enues total about $370 billion. So $4.7 billion is less than 1.5 percent. I would not use ~ percent, it is much less. Mr. KETCHTJM. Will the gentleman yield. Mr. CONABLE. I had better yield the floor because I have had it more than 5 minutes. Mr. KETCHUM. I thank the gentleman for yielding. I saw my good friend's article in the paper this morning. I am look- ing at a copy of minority views of the Ways and Means Co~nmittee report to the Budget Committee which you signed. We reluctantly accept adding $2.1 billion to $2.4 billion to the President's deficit. I think Mr. Grant is entirely correct. The CHAIRMAN. Mr. Waggonner. Mr. WA000NNER. Thank you, Mr. Chairman. With regard to the administration proposal providing for a 5-year moratorium and Q0-year installment payments at 4 percent rather than 7 percent, would you care to comment on an aspect of that pro- posal which it does not do. That is that it does not remove the existing code restrictiQns to allow you those privileges. Section 6166 provides for the terms wherein an extension to pay Federal estate taxes would be permitted, but the administration pro- posal does not remove those restrictions. It seems to me that this hinders the application the moratorium and installment propose. Are you familiar with that provision of the code, or would you like me to read it to you so that you could comment? EXTENSIONS PERMITTED Talking about extension of time for payment of estate tax where an estate consists largely of interest in closely held businesses. The conditions for extension are these: If the value of an interest in a closely held business which is Included In deter- mining the gross estate of a decedent who was * * * a citizen or resident of the United States exceeds "two circumstances". (1) 35 percent of the value of the gross estate of such decedent, or (2) 50 percent of the taxable estate of sUch decedent. What is the net effect of having those restrictions without modifica- tion in place? PAGENO="0046" 32 What is the net effect of having those restrictiOns without modifica- tion ~. It would seem to me that we are not getting nearly as much relief from the administration proposal as would appear to be the case at first glance. I think this is something that needs further analysis. Maybe you can comment on it now and maybe you would like to comment later. If you do, I would like to hear it now. Mr. WOODWARD. Mr. Congressman, I am not sure to whom you were directing your remarks. Mr. WA000NNtER. Anybody. Mr. WOODWARD. Well, I am not a tax expert, I am a farmer. I visited with people about these items and if you want a more technical report on it- Mr. WAGGONNER. Let's leave it this way. Would you have your tax people propare an answer to my posed question for the printed record of the hearings. So that you may properly respond. Mr. Chairman, I would ask unanimous consent that this information be included in the record at this point. Mr. WOODWARD. We would be glad to do that. Mr. WAGGONNER. I make this unanimous consent request, Mr. Chair- man, so that they be allowed to supply that information in writing and that it be printed in our hearings at this point. The CHAIRMAN. Without objection, so ordered. Mr. WAGGONNER. That is all I have, Mr. Chairman. [The data follows:] AD Hoc AGRICULTURAL TAX COMMITTEE RESPONSE FOR THE RECORD To CONGRESS- MAN WAGGONNER'S QUESTION AT THE ESTATE TAX HEARINGS, MARCH 15, 1976 Under present federal estate tax laws, the tax must be paid, unless an extension is granted, within 9 months after the farmer or rancher's death. This would place an insuperable burden on estates of farmers and ranchers to pay the tax if it were not for the provisions in existing law -which permit at least some relief by granting an extension of time to pay such tax. In many instances, the estate of a farmer or rancher will qualify under either the hardship rule or Section 6166 of the Internal Revenue Code which authorizes the estate to pay the tax over a period of up to 10 years. However, in many cases even the 10 year extension rule `will not be of substantial benefit and assistance since the earnings from the farm or ranch are often insufficient to pay the annual installments after living expenses are taken out plus the 7% Interest (as of February 1, 1976) charged on the unpaid amount. The increase in this interest rate from its 4% rate prior to July 1, 1975 will further contribute to the unattractiveness or in- abi~ity of electing to pay theestate tax over a 10 year period. In addition, there are significant administrative burdens imposed by the Treasury Regulations on the estate of a farmer or rancher in operating the farm or ranch after the decedent's death in order to preserve the right to pay the estate tax over the 10 year period. Written reports are required to be made by the rancher's estate to the Internal Revenue Service of transactions regarding the farm or ranch operation, which in essence causes the Internal Revenue Service to become involved in the farm or ranch business. For instance, certain withdrawals of funds from the ranch business or certain sales or dispositions of interests in the ranch must be reported and can cause acceleration of the payment of the estate tax. The Treasury Regulations also require the rancher's estate to apply all undistributed net income earned in the fourth and all subse- quent years following the rancher's death to the payment of the remaining balance of the estate tax. Thus, while the 10 year extension of payment rule can be of value in some cases, the restrictions and limitations imposed by such rule on the operation of a farm or ranch and the increase in the interest rate on the unpaid balance of the tax can mitigate the intended benefit of paying the estate tax over a period of PAGENO="0047" 33 years. As one knowledgeable commentator has said, granting additional time to pay estate taxes is not a satisfactory solution to the problem if the taxes are so high that a sale of the business is required. The CHAIm\~rA~. Mr. Pichie. Mr. PICKLE. Thank you2 Mr. `Ohairman. Mr Criswell, I know in the examples that you gave you show in two cases a tax liability of $118,~00, or a iiabili~y of $191,000 on land estimated at about $600 an acre. That is a little high for some of the land in my area, but, in any event, to try to get at the figure we. are faced with it would appear to me that a family or estate must have available in cash or the capability of convertang to cash somewhere between $50,000 or $100,000 or else the farm or ranch, or whatever it is, the land has to be broken up. Is that a fair appraisal of the problemthe farmer is faced, with? Mr. Cmsw1~L. Yes, Mr. Pickle. That is a fair appraisal. The farm does have to be broken up. Parts of it have to be sold to raise the reve- nue to pay that inheritance tax at the time of death. Mr. PICKLE. The option then would be that if they have to raise $50,- 000 to $100,000 probably the only way to do that is to sell the land because they have no assets. Mr. CRISWELL. This is right. Mr. PICKLE. That means breaking the farm. Mr. CRISWELL. This is right. Of course we are only talking about the value of the land and, if the person that is passing on has the equip- ment to .f arm this lan.d the estate would he even greater and would re- quire selling the .f arming equipm~eiit and more of the land. Mr. PICKLE. The estate would be greater but if they had to sell that equipment, we will say, to get the cash, it is the same as if you broke up the farm. . . Mr. CRISWELL. Yes. Mr. PICKLE. The prospect'~e have is that a family must have $50,000 to $100,000 or my size of a reaso~iable farm from 300 to ~00 or 900 acres, or else the land has to be sold. Mr. CIUSw~LL., This is correct. I mtgbt add to~tbat that we are talking about the revenue off the land and I am not an accountant, either, but an accountant or somebody appraising the situation might figure out where the loss of revenue from the inheritance tax might be partially gained or all gained back from the loss of income tax because of break- ing up of the family farm,. which is the most efficiently run operation there is in the tTnited Statestoday. Mr. PICKLE. The Government might lose money in the long run. Mr. `CRISwELL. Yes. Looking at it from the income tax standpoint, it could lose more revenue there than they will gain in the inheritance tax. Mr. PICKLE. The average farmer just keeps ahead of the bill col- lector. Mr. CRISWELL. Right. Mr. PICKLE. He hopes to make a payment on his equipment. If that farmer is faced with a $50,000 to $100,000 cash payment to keep it to- gether there is no chance for him. There are very, very few wl~ could. Mr. CRISWELXJ. Very few operatozs can rake up that kind of money, very few. Mr. PICKLE. Thank you, Mr. chairman. The CHAIRMAN. Mr. Steiger. PAGENO="0048" 34 Mr. S~r~iGE1~. Thank you, Mr. Chairman. I join in thanking the panel for coming. Mr. Grant, your proposal relative to the problem of the farm wife would alter the marital deduction. Is there any other method by which one could recognize the role that the woman plays on a family farm other than through the marital deduction? Mr. GRANT. Yes. There are ways that it can be done but not as ade- quately as is suggested here. Mr. STEIGER. Ms. Brookshire, do you agree with that? Is that, in your judgment, the way that we ought to handle that? Ms. J3ROOKSHIRE. I think there are methods that are available for us today, those of us who have foresight to see to the distribution of prop- erty to avoid this situation. I believe the opportunity that is ours through a small corporation today if you have foresight. However, those who are caught in the present situation will be under the control of the present law. It is not possible to think of settling the farm that we are on because our parents still hold the farm in their name and they are not modern enough to see these new methods that are now available. Therefore, the farm wife who has served on that farm for 53 years who recently becomes widowed will be subject to the inher- itance tax that is presented today. As a woman of that age she will not be spending this money. It will be the son who is in operation of that farm. He will not only have to have her pay for her inheritance tax as a widow but in a short period of time she will be out of the picture, so that he will be the direct heir. Again this severe tax. At 60 years of age it is more than likely that he will not live the 10 years or 20 years proposed that he can pay this tax so the grandson will be paying this tax of the grandmother, of the father, and now he will have another burden for there will be a third settlement of this same property tax. So it is a continuing situation where we will be living under a tax situation. Farming does not allow this much freedom at the current price level. I believe the present issue of the pressure has come because of the inflation in the last 5 years. That is the reason we are speaking to Congress with such urgency now. Inflation has not been as bad until the last 5 years, and we cannot cope with this inflation without some help. Farming is on a very narrow inargrn for every marketable product mentioned at this table. The wheat farmer does not get the price of the bread and the dairyman does not get the price of the milk. He gets a very small portion. We do not have this margin. As far as our lost revenue is concerned, we might say, "Thank you, Congress, for all you have given us but we cannot afford it." We are appreciative of all the things that are offered. Yet we like to feel that we are in a good working area and we would like to have a little as- surance that we could keep on and solve the problem. Mr. ST1~IGEn. Thank you for your comments. My concern, I must say, is to at least some extent the same concern that Barber Conabie has expressed. There is a dilemma in which this committee and the Congress will find itself. I know a family farm wife right now whose husband died and she is faced with this problem be- cause the estate tax is going to decimate her. There is no way she is going to be able to keep the farm for her children. She is going to have PAGENO="0049" 35 to sell it. I am very, very mindful of the problem that is posed for both agriculture and small business. But I am afraid that just raising the exemption will not resolve the problem. If I had to judge this committee or if I had to judge the Congress I'd say I don't see us reporting out a bill to only raise the exemption. Something else is going to come with it. Whatever bill we report out I hope will be a rational one and at least I hope we will be willing to deal with the problem. I am just grateful to all of you who gave up time to come here and try to help us resolve this issue. Thank you, Mr. Chairman. The CHAIRMAN. Mrs. Keys. Ms. KEYS. Thank you, Mr. Chairman, and members of the panel. I don't have specific questions to ask of you but I do certainly thank all of you for your testimony. Coming from Kansas, I understand well the problem this is inflicting upon the ability of the family farm to survive, and I have dedicated myself to helping this committee find the right solution. I believe that probably we can't look entirely to raising of the ex- emption but perhaps we need to examine some of the areas about the use of fair market value as assessment. The possibility of unification of estate and gift taxes, some of the other possibilities that will help remove the often forced sale of all or part of the family farm rather to pay this tax. If you have anymore specific comments you would briefly like to make, any one, to help me in that area I would appre- ciate it. Other than that, I would like to say that I do believe something must be done to remove the inequity to women in this whole picture. I have many relatives who are farmers and in the case of every one of them who have successful farms the farm wife and farmer have been equal working partners and certainly share in the achievements of that business totally together. I do not believe that the wife should have to pay inheritance taxes on half of what is already hers. I have taken my time but if there are any short comments that could help me in the area of something that you' believe would help Other than the raising of the exemption, I would appreciate it. Mr. GRANT. We perhaps will have some suggestions later. I don't have any now. I might stat~e that there are parts of Kansas, Oklahoma, and Texas where if there were a death at this time it is a foregone con- clusion that the farm will be sold. I started as a sharecropper and my wife gave every bit as much as I did to the operation. So if I pass on she has to pay the tax. It seems incomprehensible that we would leave it that way. Ms. KEYS. Thank you for your testimony. Mr. CRISWELL. Ms. Keys, if I might make a short comment there, in our statement we did, and I believe in Mr. Grant's ~nd some of the others' statements we did recommend that we tax the agricultural land on the productivity rather than market price of the land, which would alleviate part of the problem but we still feel that raising from the $60,000 to $20,000 would be fair, too. Ms. KEYS. What would you feel about taxing it in the income basis? Mr. CRIswELL. Well, this is the income from the production? Is that what you mean? 68-872-76-4 PAGENO="0050" 36 Ms. Krnrs. No; I really meant the income tax basis. Mr. CRISWELL. Of course laud is not depreciated on the tax rolls, but whatever the purchase price of the land is, if it is ever sold you pay on the gain or loss of the land. But the land does&t depreciate or have a depreciated table base like a tractor or any equipment. * Mr. BuRr~soN. Will the gentlelady yield. Ms. KEYS. Certainly. Mr. B~JRLESON. The lady has raised a very essential point in this whole issue. Certainly something has to be done about the surviving spouse problem in estate thax reform. On the valuation issue what you mean is to use the value of the property for its existing use at the time of death. We propose that if it has been dedicated to that purpose 5 years prior to the death of the decedent and for 5 years thereafter, that value is entirely reasonable. But as it is now, let me give, an extreme example-there needs to be uniformity across this Nation in the re- gional offices of the IRS because their enforcement may vary. But take an extreme example, the IRS can go out 20 miles from some little town or city and say that this property has the potential of a shop- ping center or a 40-story condominium, and place this value accord- ingly. As I said, of course, this is an extreme example. There should be a recognition of the use and character of the property at the time of death and for a period of time afterward. In all candor, I haven't quite figured out how we can get that uni- form inforcement of evaluation standards. Perhaps we. will have to get our tax experts on the staff to do it. I have thought about it a lot and still have not come up with a satisfactory answer, at least to my satis- faction. It is a very essential point you raise. Ms. KEYS. Thank you very much. The CHAIRMAN. Mr. Martin. Mr. MARTIN. I have no questions. The `CHAIRMAN. Mr. Fisher. Mr. FISHER. Mr. Chairman. I think most of my questions have already been put. it is clear that compromises are going to have to be found between the position that has generally been put forward so far this morning, and what fiscal prudence of the Government will permit. I simply would a~k the ques- tion again that you give to us, whenever you can your thoughts as to how we make up loss of revenue that may be justified, in terms of the equities within farming and in terms of keeping family farms in exist- ence. But somewhere on the spectrum something has to give because you cannot at the one time advocate a revenue loss of this magnitude and at the same time criticize Government for running deficits and allowing the debt to increase. So I think it would be very helpful to us if you would give us any further thoughts along this line which you have, because I tend to agree with my colleague, Mr. Conable, that this alone is not likely to fly. The CHAIRMAN. Are there further questions? Mr. Ketchum. Mr. KETCHUM. Thank you, Mr. Chairman. I apologize for being late this morning, particularly with the dis- trngmshed panel that you have just been listening to. I suppose I would have to admit somewhat of a parochial interest in the panel since PAGENO="0051" 37 Mr. Allen Grant and I are friends of long, long standing. He hasprob- ably done more to bring to the fore.agrictilture's position in California than any man now living. I congratulate him on his new position as president of the AFBF. Mr. Grant and I have had our agreements and disagreements over the years. I was very closely associated with the California Farm Bu- reau Federation which probably will stand me immediately with a con- flict of interest, and if indeed there is a conflict I would readily admit it. I believe that it is time that someone spoke up for agriculture in this great land of ours. I noticed a very interesting article in the paper just yesterday, Mr. Grant in which it was intimated that because cer- tain people who came from farm backgrounds sit on some of the il]us- trious committees of this Congress that there is a conflict of interest. Yet it is amazing to me that never once is there a suggestion of a con- flict of interest because attorneys sit on committees of the Congress, and in effect, of course eve~~ry bill we pass does represent a conflict of inter- est to them. I want you to know that I support you. I feel as you do that there is very strong possibility that we may indeed make some progress after all these years here in this Congress no matter what its coloration, and I hope that you and your associates on this panel will spread that word all over the United States and bring this problem to its proper perspec- tive and that is that we can't afford to wait any more just because it is an election year. I thank you, Mr. Chairman, and yield. back the balance of my time. Mr. VANIK. Mr. Chairman. The CHAIRMAN. Mr. Vanik. Mr. VANIK. I regret that I wasn't here to hear the testimony. I have read it, and I had some questions that I wanted to direct to the panel. Does anyone on the panel know what .the average estate is of a per- son who dies in the United States today? Have you any idea what that might be? Mr. GJ~NT. Mr. Congressman, I don't have the answer because I don't know how you. could strike an average. Mr. 1TANI'K. I am endeavoring to find out, because I am endeavoring to find out how many people we are talking about in this particular increase in exemption. I would be very much surprised if the average estate in Amerh~a was more than $15,000 or $18,000 net of debts, That is what we are talking about. It seem to me that it is going to be rather difficult for us to convince constituents with the average of an $18,000 estate that people who have an estate of $576,000 or some substantial farm esate are entitled to some special tax relief. My second question is, was it the idea of the panel that this would be limited to the small family farm or do we extend it to the small family business which might be a machine tool business or a~ service station, or perhaps a family owned oil well or gas well, or perhaps a family owned gravel pit or coal deposit. it is going to be very difficult for the Congress to write class legisla- tion dealing with one group of people. Did you have an idea that you wanted this solely for the farmer, or was it your thought that it would extend uniformly to whatever all Americans are able to accumulate? Mr. GEIss. I would like to respond to that. I am afraid because I am PAGENO="0052" 38 not a tax expert, and a man not familiar with the nature of many other industries I could only speak to the dairy industry and specifically as a member of the small family owned milk processing business in the United States. Just as has been expressed by the people here representing the family farm, I must say that the effect of our present estate tax laws is dev- astating upon the small independent dairy processor who has a com- mitment to have specialized equipment. Mr. VANIK. It is no different with respect to the family grocery, if there are any still around, or the family gas station, or the family auto- mobile repair shop. They are all in the same dilemma and are rendering an essential service. I assume you want it across the board. Mr. GEISS. That is correct. Mr. VANIK. In our calculations we are talking about estate taxes, increasing the exemption across the board for everyone. I want .to ask you another question. All people have other privileges under the law. You can give a $30,000 lifetime gift to those members of your family whom you may trust before your demise. You may also give each surviving spouse, give every child $3,000 a year free of any income tax or free of any Federal tax. You can also establish a trust for the handling of the estate problem. Am I correct? Assuming that, if these things are not done, for example, if a farmer has a number of children in his family, isn't it likely that he is liable to use the gift tax procedure which is available under the present law so that if we were to maximize the use of the privileges of the law as they now exist, it would permit a greater ex- emption than we have under the present law for husband and wife with the marital deduction? Mr. GEIss. I would respond to that in this way, Congressman. In- fiation has carried us to the point in 1976 where the $3,000 gift that one might make to one's child- Mr. VANIK. It gets to be smaller. Mr. GEiss. Gets to be smaller. I can't buy a truck for less than $20,000. If we are running a typical independent dairy business and I am speaking now of processing or manufacture of ice cream, it costs $50,000 for one ice cream freezer. It could take an awful lot of contributions over a period of time to children. Mr. VANIEI. You see, if you have six children and you are giving $3,000 a year for 10 years it can raise quite a lot of transfer of property. Mr. GREEN. Will the gentleman yield for a moment. Mr. VANIK. Certainly. Mr. GREEN. I hate to interrupt, but I must say that I have been traveling aroirnd my own State and this is a very serious problem. I find many farmers having their family farms plowed under by the estate tax. This question of giving your six children $3,000 a year is really unrealistic. What has happened is not just national inflation but as the cities expand into the suburbs the value of the land that a family may have farmed for generations is driven up so high by its develop- ment potential instead of as farmland that it drives these families under. Something ought to be done about it by this committee. Mr. VANIK. I am grateful for my colleague's remarks. He sounds like a very fine Senator. PAGENO="0053" 39 Mr. GREEN. I accept the nomination. Mr. VANITL I have just one other question, and this relates to the basic question that we are dealing with. If the average family farm has five children, how are you going to maintain the family farm and divide it among perhaps five children at the time of the pass over. That is going to mean that the farm really can sustain one set of managers. I know in the wheat country, for example,. a farm might be 3,000 acres and be worth about $3 million or $4 million. I don't know what it might be worth. The equipment might be worth $300,000 or $400,000, and the total number of jobs involved might be five or six with one farm manager. In effect, if this provision stays in with four or five children, in- heriting the estate with enlarged exemptions, for example, does that mean really that the five of them are going to operate the farm or does it mean that four of them are going to enjoy a rather substantial tax benefit while one of the five will probably take over the farm. Isn~t that really what happens? Ms. BROOKSHIRE. Mr. Vanik- Mr. VANIK. Yes. Ms. BRooKsmnE. If I may, please. We have within our farming operation the opportunity of a buy-sell agreement so that divisions made by the parent to the various children will then have the oppor- tunity to sell to the other children who might continue in a one-man operation or management. Mr. VANIK. Would it be your intention that when they buy-sell they would pay for the realized capital gain? If there is that buy-sell arrrangement between the children who are selling to the child who operates they are enjoying a rather substantial tax-free advantage that doesn't relate to family farming because they are not going to farm. They are going to do something else and they are going to be selling and coming into some substantial estate without paying the normal rate of taxation. Ms. BROOKSHUiE. You have mentioned earlier the possibility of the $30,000 lifetime gift in addition to the $3,000 that one may give to the children each year. It is our experience that farm people do not have tangible dollars to give to other people whether they be in the family or to the Government in taxes. Mr. VANIK. They give 100 acres a year. That is 1,000 acres in 10 years. You can do it by that kind of division. It can be divided. Ms. BROOKSHIRE. Much of the business operation, Mr. Committee- man, is that not in that kind of a tangible gift. You can't give a silo. which is worth $35,000, to one's son for that is a part of your invest- ment. That is part of your total picture. Mr. VANIK. I have reason to believe that these things are legally divisible and that these things could transfer. I think you can indeed sell a silo or sell a barn or a homestead or you can sell just plain land or you can sell equipment. All of these things are salable because I see them sold all the time. I think these things can be divided if it is the dèsigñ to do it. I am not suggesting this as a solution. I am trying to explore all of the other avenues of tax-free or reduced- taxation transfers that are available, and which I suspect are rather extensively used, perhaps not in your area, but thety are available to operators who may decide to utilize that feature. PAGENO="0054" 40 My time is up.I want to thank you very much. The CITAIRMAN. Mr. Mikva. Mr. MIRvA. Mr. Chairman. it sounds like a lot of people are running for the Senate today, and at the risk of Mr. Conable and me being the only Members left in the House', 1 would like to say to the panel that there is much more sympathy with your position than may appear when you talk about the solution. I never .knew the inheritance or estate taxes were intended to force somebody to sell a farm. That was not their original intent. The problem arise as it does in so many areas because the original farmers of that' tax `system put in a dollar amount as the exemption, and we come into that difficulty every time we use dollars and the value of the dollar changes. We ran into that earlier this year when we changed the surtax exemption from $25,000 to $50,000, and were dismayed to find that some 83 percent of the revenue loss was going, not to the small business man, but to corporations with over $250,000 a year in taxable profits, which is hardly the small businessman that we pictured we were helping when we made the change. The problem that some of us have is not with the objective of saving the farm or the small business from being sold in order to pay taxes, but to do it in a way that doesn't create a Mack truck sized loophole for a lot of people that you are not particularly interested in helping, and we are not in- terested in helping people who already are finding their way very well through the estate tax laws and doing very well with the amount of tax they pay. That i's going to take some ingenuity and I don't think it is going to be sufficient to talk about. raising the $60,000 to $200,000, or some of the numbers I saw, because when we look at how that spreads we will `find that most of that relief is going to the ~wrong people. Given the size of the revenue los's involved in that change, I would urge you to talk to your experts and anybody interested in this problem and bring some ingenuity to the problem. The problem is not with the result you seek to achieve but with how we get there, and we ought to get there' by not compounding the problem we are in by raising the dollar exemption which put us here in the first place. Mr. VANIK. Mr. Chairman. The CHAInMAN. Mr. Vanik. Mr.' VANIK. I am quoting from a Federal table, "Personal Wealth Estimated from Estate Tax Returns, 1969", which is the latest we have. We are n~t very up to date on our records so that what I say has been probably affected by the circumcstances of inflation. What this tells us on page 6 in substance, is that 92 percent of the American people have estates of less than $60,000. With a marital deduction that brings it up `higher so that I would assume that what we are talking about is tax relief in effect for 5 percent'of `the American people. I want you to understand that our political problem is so that you have some feeling for what we have to experience. We are dealing with taxpayers whose income is withheld and who have very little PAGENO="0055" 41 property, who, by the time they clear their~mortgage which is real]y `a rental of property throughout their lifetime, end up with very little. Eeally~ What you are suggesting here is' a special kind of tax relief for about 5 percent of the American people. I think it is going to take a very ~trong convincing case tO impress upon U.S the critical need for doing something for 5 percent of the people and to cOnvince the ~5 percent on the other side who are paying substantially a tremendous part of the ta~ burden of this country through income taxes that someone else with a $522,000 estate or a $300,000 estate needs some kind of special relief. I think that you are going to have to do a lot of work among the grassroots of our people who are the other 95 percent who might die too~ They are trying to develop enough capital to educate their children, to buy an automobile, to perhaps buy ~a little farm or buy a litle place or get a little place for their retirement, and it is very, very difficult for me to really go back to the people who are in this plight, desperately trying to manage their affairs and also suffering the tremendous impact of inflation, and say to them that "It is to your good and welfare and the good and welfare of all of America that we provide this big tax relief, substantial tax relief to 5 percent of the people who have estates over, substantially over $120,000." Ms. Ki~~s. Would the.gentleman yield. Mr. VArnK. I am happy to yield to my colleague. Ms. KEYS. I just wanted to suggest to the gentleman that perhaps the ultimate result of allowing this practice to continue and the demise of the family farm to compound would be the aggregate corporate take-over of all the production of food in this country. I don't believe that would be in the interests of any of our constituents. Mr. VANIK. I am really not prepared to argue that because my family had a family grocery store, and we were taken over by cor- porate activities. We just couldn't compete. I don't know that the communities in America have suffered a great deal because of that because `the salaries and wages of the people who now work in these places is much higher, their takehome pay is much greatei~ than it was in the individual operation. I don't suspect for one moment that if we fail to provide this relief that the farmland is going to be idle. I think it is going tO produce food one way or another. A new entrepreneur will move into it and produce from it. From the standpoint' of productivity the whole issue relates to what is most efficient, what will produce the greatest amount of food tuider the highest labor standards, `under the most useful and most profitable conditions, I think that i~ ultimately the test and', just as my family had to close the doors on the neighborhood grocery store to the growing' powerful A&P or Giant or whatever else came by and destroyed this, I think the people are still eating. They are buying food and are buying it in a competitive market. I think they are probably satisfied with it. In spite of this there has been a resurgence of the family store because you get the extra hours stoke that now becomes a franchise, an individually owned business, and there has been `a new area for family activities~iñ the retail business. ` PAGENO="0056" 42 So all I want for my people is an adequate supply of food at the best possible price under conditions in which they have money left over to buy it and if we provide extremely widened exemptions for tax relief for 5 percent of the people, it means that the other 95 percent are going to have to pay more. That is just all it is. I have to tell my 95 percent of the people- You are going to have to pay more in taxes or, perhaps, never less, because we have to provide special relief to 5 percent of the people who are in this special area seeking a tax benefit. I yield to my colleague. Mr. GREEN. I thank the gentleman for yielding. You made one statement that does not correspond with my experi- ence. That is the assumption that this will continue to be a farm. One of the problems is that we are developing are farmland. We are build- ing houses all over on it, and some of the best farmland in this country is being lost. There is a way. The goal is not to give people tax breaks here. If people are going to use some kind of farm exemption and pay no tax and then to turn around and develop the land we should provide for recapture of the tax benefit. The object here is not to give people tax breaks but to keep farmland in farming and keep family farms going. Mr. VANIK. I say to may f riend from Pennsylvania that he ought to work at the State level because his State of Pennsylvania provide no exemption for a widow, none for a minor child, none for an adult child, and none for a brother and sister. I think there is great need there for work at the State level. You have work to do in your State. Ms. BuooKslmtn. Mr. Vanik, I would like to speak to one issue. The quotation that you have just given is from a 1969 report. Mr. VANIK. I said that. Ms. BROOKSIIIRE. Probably the urgency for the presence of this panel is because we are in 1976 and the inflation has hit us so drasti- cally in these last 6 years. The 95 percent that you speak of, a good share of those will be a part of that 95 percent today because of the inflated figures. We are probably talking about 75 percent versus 25, perhaps only 65 percent versus 35 percent, because the inflated prices have pushM all of us into that figure. Mr. VANIK. I might ask you what was a quart of milk selling for in 1969. Ms. BROOKSmRE. Would you believe that it was very close to the quart of milk that you are buying today? Mr. VANIK. I don't recall it as that. I think I can give you that figure in about 5 minutes because I made a study of consumer prices in 1969, which I have in my office. I am not prepared to respond to it but I will have to get my answer into the record after I check my figures because I am trying to quote my questions from those records that I have available. iMrs. Brookshire submitted the following:] I would also like to enter some 1969 and 1975 figures for comparison. In Decem- ber 1969 in the Indianapolis market-Federal Order No. 49-the price paid for a hundred pounds of milk was $5.90. In December of 1975 that figure bad increased to $9.72, a substantial figure numerically, but if the cost to produce that hundred pounds of milk has increased that much or more, it has little meaning. In those same years our labor costs have increased at least 2% times . . . every phase of PAGENO="0057" 43 handling that milk from farm to table, through many complexities, has also ex- perienced the labor increase, which cost is directly passed on to the consumer. Would that we could pass on our share of the increased costs as easily . . . in ~most studies it is found that the price paid by the consum~r is a little more than double What is received by the farmer. The price you have paid for a quart ~f milk was paid with inflated dollars. You are still feeding your family with 17 per- cent of ~eur income. Mr. VANIX. I would simply say that the inflationary impact about which ~ou complain has been uniform. It has not singled out the farmer. It hasn't singled on the family farm. It has afflicted the whole t~ountry. Ms. BRooI~smRE. Right. Mr. VANIK. From where we sit I would say that it has affected the consumer, the retired people, the children of America probably more than anyone else. I just had to sit down and write my son's college a check where the tuition was probably twice what it Was in 19~9. Ms. BnooKsmEE. And it is the children of America that we are here to protect today. Mr. VANIK. The point that I want to make is that I think that this situation is aggravated indeed but I would say that it is aggravated in a way that perhaps would carry the same proportion throughout our society. First, I don't think it disturbs or changes the basic argument that I made, and that is that the tax relief that you seek is directed to a very small percentage of the American population, 5 percent, 6 percent, 3 percent. Whatever it is, it is a very small proportion of the American people. Mr. KEPCnUM. Will the gentleman yield. Mr. VANIK. I yield. MI~. KETCHTJM. I thank the gentleman for yielding. I would have to agree that what he is saying is that it affects a very small number of people, and I would call to the gentleman's attention that the very minuscule amount of the population of the United States are feeding and clothing all America, all America that has moved into the suburbs, and the urban population. I can tell the gentleman from experience that what the gentlelady is saying is entirely correct. When I started to farm I could buy a harvester to harvest my grain for in the neighborhood of $9,500 and 12 years later $37,000 for the same harvester, and was still receiving $2 a hundredweight for my grain. Mv; VANIK. I say to the gentleman if I go back to those days I have a Chevrolet with a heater and defroster that I bought for $600. Mr. KETCmiM. With a lot of junk that we made them put on it. Mr. GREEN. Why don't you say that you are still driving it. Mr. VANIK. I am still driving it because as a Member of Congress I have been affected by the inflationary impact. The CHAIRMAN. Are there further questions? Mr. Waggonner. Mr.. ~WAqGONNER. It looks like some people are getting uptight. I think it might be well to remember what Will Rogers well said. It might be a good point of departure. He used to say, "Things ~in~t like they used to be, and as a matter of fact, they never were." Mr. GRANT. Mr. Chairman. The CHAIRMAN. Mr. Grant. PAGENO="0058" 44 Mr. GRANT. One brief statement to Congressman Vanik, that his parents' grocery store was closed down by competition, not by taxation. The CHAIRMAN. Let me express my appreciation for your testimony. Let me ask you to do this: As we proceed we are going to develop legis- lative recommendations with which you have worked. Because it has been so many years since we have worke4 with the estate and gift taxes, many abuses have developed. Before we do what you are suggesting, we will have to con~icler the basic equities and processes and to have a broader reform. As we con- sider these recommendations it would be my hope that you would stay abreast of our actions and, well, all of our meetings are public, and you will feel free to come back to us with additional recommendations as our legislative process continues. With that, let me thank you again for your testimony. Mr. CruSwELL. Mr. Chairman, may I make a remark here. The CHAIRMAN. Yes. Mr. CRISwELL. I think it is a pretty good point to point out the inflation and probably the income of the people timt Congressman Vatiik is talking about. The cost of living, or the cost of their groceries, is still only less than 17 percent of their disposable income. This is about the same figure that it has been for 20 some-odd years. Thisitem should point out the difference in the amount of income and the infla- tionary show. Mr. VANIK. I will respond tothat. I just want to say, Mr. Chairman, that I would hope that members of the panel, in order to help us in this matter, would give us a report as to what is being done in their States or in the States that they know of in order to increase the ex- emptions at State levels. If the arguments that you have presented have substance, then I think you should show us why the States have not been able to pro- vide1a $60,000 exemption with a $60,000 marital dednction, and I would like to know what progress is being made among the States dealing with the same problem much more intimately than we are, what chances there are of the States increasing their exemptions so that what you urge here might be done in tandem with the States because, frankly, if we reduce Federal taxes and the States remain where they are, or increase their levels of taxation, then we are simply transferring revenues from the Federal Treasury to the State treasury. I would like to know what positive strides have been made in the several States to deal with this problem of preserving the family farm. You might add that to your statement, if you wOuld. The CHAIRMAN. Mr. Jacobs. Mr. JACOBS. Thank you, Mr. Chairman. I wondered would the panel object to a provision by which heirs would continue with the same exemption if they chose to sell the in- herited property as opposed to retaining it for farming' purposes, but where there would be increased exemption or perhaps a delay in that portion of the estate tax during the period they continued the property as a family farming operation, question mark. Mr. WOODWARñ. That is definitely a part of our idea. We feel that it should be maintained as a family farm by putting a period of so many years for it to be consistent in being a family farm. PAGENO="0059" 45 Mr. JACOBS. I mean if heirs farmed for 10 years and decided they would let the place be developed fot~ residential purposes you would have no objection to picking up or recapturing the tax at that time when this "humongeous" profit was to be made, to use a word my teenage nephew nses. Mr. WOODWARD. I haven't gone into it that far. Maybe Mr. Grant has. Mr. Git~wr. That is one of the suggestions, that has been proposed, but it has real problems in it. The CHAIRMAN. Thank you very much. We appreciate yc~ur testi- mony. [Mr. Criswell subsequently submitted the fo'lowing:] PLAINS COTTON GROWERS, INC.,. Lnbhock, Tetv., . farcli1 14), 14)76'. Hon. At ULLMAN~ Chairman, Committee on Ways and Means,, U.S. House of Representdtives, Washington, D.C. DEAR Mn. CIIAIRMAN: In response to your request for additional Information concerning estate taxes, I am enclosing `(1) a case history submitted to us by Dorothy Ann Kinney, Attorney at Law, Amarillo, Texas, and (2) a copy of a statement made on the floor of the House by the H~noráble Paul Findley. I would also like to comment furthOr on the thinking iñtrdduc~d `by Congress- man Vanik to the effect that those of us on the panel Monday, March 15; were asking for a "special tax break" for only about five percent of the American people. The family farmers and family businessmen of America pay income taxes on everything they earn, inst as do wage earners and others whose estate may fall below thO $120,000.00 total estate tax exemption. We are not suggesting that the family farmer and small businessman' be exempted from his share of the income tax load, but that a portion of their estates be exempted from a tax load that Mr. Vanik's `4otliter 95 percent" are never subjecied `to. The estates belougiug to the five percent of the popu1,atio~i referred to by Mr. Vani1~ were built with dollars left to that five, percept after they had paid their fair share of the national tax load. They were built by a willingness to work longer hours than the. other 95 percent were willing to work and by. a willingness to live more frugally than the other 95 percent were willing to live,. Therefore I see no justtfication, for the c~iarge that we are `asking for "special ta~ relief." . ., Again, we appreciate your committee's work and If we can be of any servicO whatsoever, please call uppn u~. , , Sincerely, ` ` W. 13. CiuswEtL, ,PrOsidènt. Enclosure. . ` AMARILLO, TEZ., Mqrc1i~ 1~, 1976. Re estate of Sam E. Lasley, deceased, Marble Falls, Tex. 0. A. FANNINe, " ` Eccecutive Assistant, ` ` ` ` Piains Cotton Growers, Inc., ` `` Lubbock, Teoy, . ` ` - DEAR Silt: At the request of Ray Joe Rlley,of Dftnmi'tt, Te*as, 1 am furnishing you an example of the, bardshil~ caused by the `present $60,0Q0~00 estate tax exemption. Phe e,xecutrl~, l~as approved the release of thiS information.' A cltse' in' point is t~e Estate of' Sam Lasley, ~eceased. Mr, Lasley, a former resident of Stratford, Texas, develo~ped cancer several years before his death. He was forced to leave `his farms In Sh~man `County `and nioi~e to `Marble Pulls, Texas. Knowipg that death was imminent, he arranged `for the installment sale of his best sections of farm' land shortly l~efore his death. ¶I~he eale was con- summated after his death. , ` ., ` ` PAGENO="0060" 46 Mr. Lasley's net taxable estate, including the land he contracted to sell, was $444,562.78. His four sections of land, small mineral interests and home had a gross value of $418,956.00. The total gross estate tax was $127960.09. The net estate tax, after deductions of credit for Texas inheritance tax, was $117,777.61. The estate tax retui~n was approi~ed by IRS as filed. Mr. Lasley's estate at his death had insufficient liquid assets to pay the taxes. He b~l stocks and bonds of $1,965.84 and mortgages, notes, and cash of $80,822.50. Mr. and Mrs. Lasley had lived frugally in order to accumulate the cash needed at death, but years of self-denial still did not produce sufficient cash to pay the estate and Inheritance taxen After reserving the amount which would be required to pay the estate's share of farm expenses under the farm-lease agreement for the crop year and paying indebtedness, the estate was able to pay only $54,777.62 of the estate taxes due at the time the return was filed. The estate elected to pay the balance over the 10 year period provided under Section 6166. At the time the decision was made, the interest note on deferred installments was 4%. On July 1, 1975, the interest rate was raised by the government to 9%, thus increas- ing the estate's problems. The estate realized no taxable Income in 1974. The return for 1975 is not avail- able to date. Cash was further depleted by the expenditure of more than $10,000.00 in repairs on irrigation wells after Mr. Lasley's death. The net result of inadequate and unjust exemption of $60,000,00 which has not been raised to reflect inflation and the value of the dollar is that this estate has had to borrow from the surviving widow funds with which to pay the balance of the estate tax and finance farming expenses. This result was reached inspite of the frugality of the decedent and the sale on an installment basis of one of the 4 sections of land owned by the decedent and his wife at the time of his death. I strongly urge that the estate tax exemption be raised to at least $250,000.00. Sincerely, (Mrs.) DOROTHY ANN KINNEY. [From the Congressional Record, Mar. 11, 19761 PRESERVING FAMILY ENTERPRISE AND FAMILY FARMS Mr. FINDLEY. Mr. Speaker, the family farm Is one of the hallmarks of American agriculture. The corner drugstore, the car dealership, hardware and furniture stores are all parts of Mainsti-eet, U.S.A. Traditionally, they have been family run and family owned. Over the years at great sacrifice to moni and dad, they have been established or purchased. Often parents have used the family farm and the family store to train their children bow to run a business and t~ teach them the virtues of hard work and honesty. The weekly allowance was earned by Sweeping the floors, waIting on customers, or tending livestock. Family enterprise has been a part of what has made America great. A greater percentage of farms are family owned today than ever and this trend must be preserved. Family ownership of nonfarm businesses Is also exten- sive and should be encouraged. When dad dies, mom and the children too often sell to an outsider, rather than continue the business. The main reason for the interruption of family ownership is the burden imposed by estate taxes. To facilitate the transfer of family ownership from one generation to another, T am introducing a bill to increase the exemption for Federal estate tax purposes and to provide extension of time for payment of estate taxes for small, family, and closely held businesses. My proposal will ease the liquidity problem which feces family farms and small businesses under the present Federal estate tax code. It will also help preserve and encourage ownership of family enterprise, both on Mainstreet and on the farm. The backbone of America has been the mdi- virliial operating independently, working for the needs of the family. Why Increase the exenmtion? Mv unswer: `to preserve family enterprise. Info - ti'rn should not be permitted to destroy family enterprises. When tho present $60,000 estate tax exemption was written into law, few working~Americnns and small businesses had estate tax problems. In fact, ~60,000 was established when the dollar was worth `a lot more than it Is today. I propose that the estate tax he increased substantially to adjust for the effect of infLation. PAGENO="0061" 47 When the present exemption was adopted, only 1 per~ent `of the estates In this country were in excess of $`60~000. A 100-acre farm in Illinois was worth $8,600. Because of inflation, that same farm is today worth over $200,000. All of us know `of hard-working i'n~1ivic1u'als who never earned more than $5,000 to $6,000 a year hut who, because of inflation, now have estates in excess of $60,000. Mom and dad bought a few acres `at a `time, fa'~i-med `the land, and raised the kids. Now when dad 41es, mom finds `that `she must pay `burdensome taxes to keep the farm. My proposal, to increase the exemption, would alleviate this problem. `Why the pr'o'p~s'al to stretch out `the `time in which to make payment's of estate taxes? An increase in the estate tax exemption will, not solve all of the problems for many farmers and small businessmen. Because `of their `hard work and suc- cess, some will still have estates larger than the increased exemption. My stretch- out proposal will make it easier `for `the spouse and `for the children to pay t'he tax due on the larger estate. It `will allow `the small businessman and farmer to pay the obligation overtime and at `a reasonable rate of interest. It will make it easier to continue the family ownership of a farm or small business following the death of mom or dad. It will help the young wife to preserve the estate if her husband `dies `so that She can continue to raise the children. It will help preserve family values and family bu~iness for generations of Americans. My proposals will change `the law `and `make it unnecessary for families to sell the family or business in `order `to obtain cash t'o pay Federal esbate taxes. Estate taxes were originally imp'osed because our society belieyes that no gen- eration should be able to rest entirely `on `the work `of `others. But the es'ta'te tax was not set so low as to prevent one generation from helping another generation get started in a family enterprise. To have done so would have stifled the free enterprlse syste~ Which `ha's contributed so much `to our gre'at land. With Infla- tion, the presen't level `o'f exemption `works to destroy the very enterprise `th'at it originally `sought `t'o protect. The challenge now is `to the Congress to modernize the estate tax law and make it conform to the realities of 1976. Let us all work to increase the exemption from estate `taxes for `all Americans `and for legislation that will stretch ou't payments of estate taxes for family `businesses and farms. For many small `businessmen `and farmer's, `the latter proposal will be as helpful as an increase in the exemption. It is time `to fight for and protect `the family enterprise. As President Ford recently said: Too much `love and to'o much labor `goes into `the development o~ a paying farm (`and he migii't have added small business) `to dismantle it with every new generation. Let us preserve our family enterprises-our farms and small businesses- as vital to our American heritage. The CHAIRNAN., The hearing wifl resume at 2 o'clock this afternoon. We have next a very distinguished and important panel `and I hope the committee members will all `be `here `at 2 o'clock to hear the panel. [Whereupon, at 11:45 p.m., the committee proceeded to other busi- ness, and the hearing was recessed to reconvene at 2p.m.] AFTERNOON SEssIoN The CITAIRMAN. `Our next witnesses in this hearing are a very im- portant panel. Thomas A. Melfe, American Bankers Association; Mr. Butala and Mr. Butler, American Bankers Association. Mr. William Penick of the American Institute of Certified Public Accountants. Chamber of Commerce, Mr. Walker Winter, and Mr. Robert Statham. National Realty Committee, Mr. Albert Walsh. And from the Pi~blic Citizen Tax Reform Research Group, Mr. Robert M. Brandon, `and Mr. William Pietz. PAGENO="0062" 48 A PANEL CONSISTING OF THOMAS A. MELEE, CHAIRMAN, TAXA- TION CON1VIITTEE, TRT)ST DIVISION, AMERICAN BANKERS ASSO- CIATIO1~, ACCOMPANIED BY J. H. BUTALA, JR., AND PAUL F. BUTLER, MEMBERS, TAXATION COMMITTEE, TRUST DIVISION, ABA; WILLIAM C. PENICK, CHAIRMAN, FEDERAL TAX DIVISION, AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS, ACCOMPANIED BY ARTHUR HOFFMAN, CHAIRMAN, COMMITTEE ON FINANCIAL AND ESTATE PLANNING, AND JOEL FORSTER, DIRECTOR, TAX DIVISION, AICPA; WALKER WINTER, CHAIRMAN, TAXATION COMMITTEE, CHAMBER OF COMMERCE OF THE UNITED STATES, ACCOMPANIED BY ROBERT R. STATHAM, DIRECTOR, TAX AND FINANCE SECTION, AND DONALD McDON4LD; ALBERT A. WALSH, PRESIDENT, NATIONAL REALTY COMMITTEE; AND ROB- ERT H. BRANDON, DIRECTOR, PUBLIC CITIZEN TAX REPORM RESEARCH GROUP, ACCOMPANIED BY WILLIAM PIETZ, STAFF ATTORNEY The CHAIRMAN. First we `will hear them in that order. First the group from the American Bankers Association, Mr. Melfe. Welcome to the conimittee. STATEMENT OF THOMAS A. MELEE STJMMARY If changes are to be made in the estate `and `gift tax laws `and the current basis rule for property transferred at death, the ABA has developed some alternatives for consideration. They include: 1. Rates and exeniptions.-The estate `tax exemption would be increased to $100,000, less `any part of the $30,000 gift tax `exemption that is used, but the exemption would operate us a credit against the estate tax `at the lowest rates of tax. The estate `tax would be lowered, particularly in the $100,000-$500,000 range.. 2. Farm.~ and other closely held businesses.-A partial forg1venes~ of tax plus Interest wOuld be granted for these ass~ts provided they qualify for deferred payment of the estate tax under section 6166 and meet certain other. require- ments. The 4% interest, rate on `amounts deterred under this section would be reinstated. 3. Basis.-The iniposition of an additional, or appreciatlön,~ estate tax (AET) o t appreciation included in a decedent's estate. 4. eneration-skipping.-The Imposition of a transfer tax upon the terinina- of a limited `trus't interest by treating the trust property as having been trans- fer.~ed by the 1~enefiei'ary ~f such limited interes't when the disposition of income and principal after such termination does not meet certain requirements. In general, shifts of benefici'al in'terests among the fam1~y of the person creating the trust would be exempted from the tax. The terth "family" includes `ancestors, spouse, children and grandchildren, `but not great grandchildren. 5. Uniflcation.-~F'or the purpose `of determining the ra'te `of tax `applic'able to trausfei~s at death, transfers `during life would be treated as death transfers. ~i. Mo~rital deduction.-The amount of the marital deduction would `be incteased to the greater of $250,000 or one-half of the decedent's adjusted gross estate, plus certain employment benefits. Mr. M~nn~E. Mr. Chairman, an'd members `~f this committee, my name is Thomas A. Melfe. I am `chairman of the taxation committee of the trust division of the American Bankers Association und on executive vice president of United States Trust Company of New PAGENO="0063" 49 York. I am accompanied by Paul F. Butler, vice president and asso- ciate counsel of State Street Bank and Trust Company of Boston, and J. H. Butala, Jr., `a vice presideut of Cleveland `Trust Company, both of whom are former chairmen of `the taxation committee, At the time the ABA testified before this corrnnitt~ee in 1973 on the same subjects we filed a draft transfer tax statute and accompanying comments dealing with the entire transfer tax area `and the income tax basis rule. With your permission, we would like to resubmit the statute, and comments, and a commentary thereon. A primary purpose of the statute was to develop alternatives re- sponcling to the criticisms of existing law, with particular emphasis upon (1) the `basis rule, (2) generation-skipping transfers, (3) uni- fication, (4) the marital deduction, and (5) rates and exemptions. Since 1973 we have continued to review our alternatives, with the result that we have made changes in the unification and marital de~ duction areas. As to unification, our original statute fully integrates the present gift and estate tax laws into a single transfer, tax system. If a change is to be made, we now prefer a simpler approach which accomplishes the policy behind unification-that is, to have the rates applicable to transfers at death reflect taxable gifts made during life. However, rather than a single transfer tax system, we would retain the present dual tax system for determining the rate of tax imposed on. gifts and when a gift tax becomes payable, thus avoiding the neces- sity of substantial new law. The policy change would be made by sub- stantially adopting section 601 of H.R. 1040 introduced in 1975 by Mr. Corman of this Committee. Our position on this issue, as well as other changes, is conditioned on there being no net increase in the overall tax cost of lifetime and death transfers. Also, our initial position regarding the `marital deduction was that present law should be changed to permit a current beneficial interest, that is, income interest, in property to qualify for the deduction. For technical and policy reasons we now believe present law should be re- tained,,requiring either an outright transfer to the ~ui~ig' ~ponse or an th1come interest plus a general power of appointment over the property. Although shifting to a current beneficial interest `test would eliminate an existing requirement for qualification, we `are concerned that it would ca;use more complexity and increase controversials with the Internal Revenue Service, As to .the amount of property, which m~y qualify for the marital deduction, we believe current law should be liberalized so a,s t~ permit the greater of $250,000 or one-half of, a, decedent'~ adjusted gross estate to qualify, his change, when corn- brned with our proposed $100,000 exemption operating as a cre4i.t, would mean that there need be no estate tax `on any estate of $350,000 or lç~ss where there is a surviving spouse. l~states of less than $350,00~_-~ comprise over 85 percent of all taxable estates.. With ~r~spect ~on ski pirw trans er , current law imposes a tax on the transfer of comp e ~ .eontro over property, but a shift of limited intç~rests in property without such a change in control is not a taxable event. Although most trusts are of a relatively short dura- tion, a ~trust embodying a succession of interests lacking the control element could be insulated from estate or gift ta~ in the extreme case for 100 years or more. PAGENO="0064" 50 The ABA proposal would shorten the period of time during which property can be held in trust and insulated from potential tax lia- bility, to no longer than the lives of a decedent's children. A distribu- tion from the trust to the creator's family-his spouse, children, and grandchildren, would not cause taxation, and where taxation results, our approach would in effect include the trust property in the estate of the skipped generation, usually a child of the decedent. Our sug- gested alternative is complex, but it is only applicable to long term trusts which themselves are complex. ~ Probably the most controversial issue is whether a change should be made in the current income tax basis rule for a decedent's property. After considering and rejecting the capital gains tax at death and the carryover basis solutions, as every major professional organization in- volved in the administration of estates has done, because either solu- tion would cause great complexity and substantially increase the time and cost required to administer estates, we searched for a more satis- factory alternative. That alternative is an additional, or appreciation, estate tax (AET) on net appreciation included in a decedent's estate. ri%he tax would be imposed at a flat rate in the range of 14 percent. We believe the AET is by far the simplest change which has been suggested. We also believe that it is the fairest change that has been suggested in terms of its impact upon estates of varying size with the same percentage of net appreciation. Nevertheless, we continue to feel, as we did in 1973 when the AET concept was first suggested, that no change shoud be made in the basis rule because current law provides a better balance in terms of fairness and simplicity than would any sug- gested change, including the AET. An important point to remember is that unrealized appreciation is a significant part of most estates in excess of $200,000 and this appreci- ation is already subjected to estate tax. Also, proof of basis would be a problem in many cases and where it could not be proved excessive taxation would result. In our opinion the real loser from any change in the basis rule would not be the large estate, which has the wherewithal to keep complete records and protect itself in controversies with the Internal Revenue Service, but the medium size estate where the cost of this protection becomes disproportionately large. During the last year interest has increased substantially in the level of taxation issue, which includes rates and exemptions and the special problems of farms and closely held businesses. Many articles and edi- torials have discussed this subject. It has even received television cov- erage and has taken up a good bit of space in the Congressional Rec- ord, particularly during the last 4 months. When we testified in 1973 we did not take a specific position on farms and other closely held businesses. During the past few months, the ABA has developed a posi- tion on this matter, which I will refer to shortly. We continue to believe the estate tax exemption should be increased to $100~000, less any part of the $30,000 gift tax exemption that is not used. But we feel the $100,000 should operate at a credit against tax at the lowest rates of tax rather than as a deduction against tax at the highest rate or rates of tax as it now does. This change would elimi- nate all estate tax on estates of not more than $100,000, which would comprise about 45 percent of all estates paying some tax. President Ford has announced that the administration is going to propose an exemption of $150,000, which is estimated to produce a PAGENO="0065" 51 revenue loss of slightly more than $1 billion. The revenue loss from our proposal would be only a small fraction of the $1 billion figure. If this committee desires to reduce estate tax revenues by a substantial amount we would suggest that a more modest exemption increase ac- companied by rate reduction, particularly in the $100,000-$500,000 range, would be a fairer tax policy. The level of taxation is the most important issue for this committee to decide. We respectfully suggest that this be done before dealing with specific areas. Otherwise, a coherent and balanced approach to the entire transfer tax area becomes difficult to obtain. At the heart of the level of taxation issue is whether the estate tax should have a significant impact on the estates of persons iii what is generally regarded as the middle class. Since 1942, when the exemp- tion and rates were last changed, the middle class has been drawn into the estate tax web. You must decide whether this development should be continued, accelerated, or halted. The ABA believes the problem which the payment of the estate tax raises for many farms and closely held businesses is real. A sale is often required even though members of the family would like to con- tinue in the business. Some tax relief should be granted in these cases. The President has outlined an administration tax relief proposal. Assets which would qualify for the relief are those which meet the re- quirements of the present law for payment of the estate tax in install- ments over a 10-year period. We believe the administration is on the right track but needs to slow down a bit and get a new engine in order to get safely to its destination. `I hree additional qualification requirements should be imposed (1) that the asset be held for 2 years prior to death, (2) that it comprise 65 percent of the decedent's adjusted gross estate, and (3) that the family actively participate in the conduct of the business after death. We also suggest that partial forgiveness of the tax plus interest, in a percentage which increases each year be substituted for the adminis- tration's 5-year moratorium. The moratorium is, in effect, a 5-year noninterest bearing loan on the amount of the estate tax attributable to the qualifying asset. We do not favor extending the payment period from 10 years to 20 years. We do agree with the administration that the interest rate on the deferred tax should be returned to 4 percent. Finally, we recommend that the maximum amount qualifying fbr special treatment be $400,000 rather than the $300,000 proposed by the administration, and that the dollar-for-dollar reduction for this treat- ment when the value of the asset exceeds the maximum figure should be made much more gradual than that proposed by the administration. Mr. Chairman and members of this committee, the ABA appreciates the opportunity to testify on this most difficult and controversial area of the tax law, and we hope that the materials we have submitted for your consideration are helpful. The association would be pleased to assist the committee and its staff in any way you deem it useful. The CHAIRMAN. Thank you very much, Mr. Melfe. Without objection, the supplemental materials wi]l be included in the record. They are quite voluminous. On the other hand, extremely valuable. You have probably done more work in this area than any other group. [The prepared statement and materials referred to follow. Oral testi- mony continues on p. 309.] 68-872 0 - 76 - 5 PAGENO="0066" 52 STATEMENT OF THOMAS A. MELFE ON BEHALF OF THE AMERICAN BANEERS ASSOCIATION BEFORE THE COMMITTEE ON WAYS AND MEANS UNITED STATES HOUSE OF REPRESENTATIVES ON ESTATE AND GIFT TAX REVISION March 15, 1976 Mr. Chairman and Members of the Committee: My name is Thomas A. Melfe. I am the Chairman of the Taxation Committee of the Trust Division of the American Bankers Association and an Executive Vice President of United States Trust Company of New York. I am accompanied by Paul F. B~tler, Vice President and Associate Counsel of State Street Bank and Trust Company of Boston and J. H. Butala, Jr., Vice President of Cleveland Trust Company, both of whom are former Chairmen of the Taxation Committee. The American Bankers Association is a trade association composed of about 14,000 banks or some 96% of the banks in the country. Approximately 4,000 of the banks exercise fiduciary powers serving their customers as trustees and executors. Thus, the Association is keenly interested in any changes that might be made in Federal estate and gift taxation. The Trust Division of the American Bankers Association (the ABA) testified before this Committee on estate and gift tax revision and a change in the basis rule for a decedent's property three years ago in March 1973. At that time, a Discussion Draft of a Transfer Tax Statute (Draft Statute) and Explanatory Comments (Comments) were submitted containing alternatives for changes in the law. We are resubmitting the Draft Statute and Comments as Appendix A to our statement. The purpose of the Draft Statute was to develop constructive al- ternatives for change that respond to the criticisms of current law, with particular emphasis being placed upon the following major areas: PAGENO="0067" 53 1. The income tax basis rule for a denedent's property; 2. Generation-skipping Transfers; 3. Unification; 4. Marital Deduction; 5. Rates and Exemptions; and 6. Charitable Deduction. We wish to re-emphasize that our organization does not favor enactment of each of the alternatives in these major areas. The most significant new development since 1973 has been the increased attention being given to exemptions and rates, viz, the level of taxation issue. A focal point has been the effect of the estate tax on "family farms" and other closely held businesses. This subject was considered last year at hearings of the Senate Select Committee on Small Business. This year farms have been the subject of articles and editorials in many newspapers, including a front page article in The New York Times of February 15, 1976. The Adminis- tration has announced that it will propose (i) estate tax relief for farms and other closely held businesses which qualify for deferred payment of the estate tax under section 6166 and (ii) increasing the estate tax exemption from $60,000 to $150,000.~ We hope that the level of taxation issue will be considered and disposed of by this Committee before it deals with the specific areas of concern. If this is not done, a coherent and balanced approach to the entire transfer tax area becomes difficult to attain. To illustrate, an increase in the exemption to the range of $120,000 to $150,000 would result in an estimated revenue loss of between $1.3 and $1.7 billion dollars, or about 30 to 35% of the estate and PAGENO="0068" 54 gift tax revenues for fiscal 1975. In considering this area, the ABA has assumed that the tax revenues will not be substantially increased or decreased. Such an assumption necessarily accepts the fact that the estate tax, which was once regarded as being only a rich man's tax, now has a signficant impact on the middle class. This point was made in the Wall Street Journal's lead edi- torial of March 10, 1976. A determination should be made whether this is a development which should be continued or halted. The ABA has continued to review the alternatives it presented to this Committee in 1973. Two changes have been made in the major areas of unifica- tion and marital deduction and one on a less significant but still important subject, the interest rate payable on estate tax which is attributable to farms and other closely held businesses and is eligible for a 10 year payment period under section 6166. The major changes are, first, to prefer the "simplified" unification approach described in the Commentary and, in general, contained in section 601 of H.R. 1040 introduced by Mr. Corman in 1975 rather than the full integration of the estate and gift taxes contained in the Draft Statute and, second, to continue existing law concerning the qualitative requirement of the marital deduction that the surviving spouse be given control over the property qualifying for this deduction rather than merely a current beneficial interest in this property. The unification change has been made for two reasons. First, it requires no change in substantive law, which we regard as desirable. Second, it permits the Committee and its staff in the limited time available to devote such time to other subjects in need of change. The reasons for the marital deduction change are discussed in the Commentary. We have always had reservations as to a shift to a current beneficial interest require- ment, and in 1973 described our support for such a requirement as "hesitant". PAGENO="0069" 55 The other ABA change of position is to support a return to the 4/ interest rate for estate tax eligible for deferred payment under section 6166 The ABA has recently prepared a revised Commentary discussing the major areas where changes has been suggested and the new issue of the taxation of farms and other closely held businesses. We are submitting the Commentary as Appendix B and believe you will find it helpful in analyzing the major issues and understanding the ABA alternatives. An effort was made to prepare the Commentary in nontechnical language Each area discussed is divided into four sections, current law, major proposals for change, ABA evaluation and ABA alternative * The ABA alternatives in the major areas may be described briefly as follows: 1. Rates and Exemptions - the estate tax exemption would be increased to $100 000 less any part of the $30 000 gift tax exemption that is used but the exemption would operate as a credit against the estate tax at the lowest rates of tax The estate tax rates would be lowered particulatly in the $100,000 - $500,000 range. 2. Farms and Other Closely Held Businesses - a partial forgiveness of tax plus interest would be granted for these assets provided they qualify for deferred payment of the estate tax under section 6166 and meet certain other requirements The 4/ interest rate on amounts deferred under this section would be reinstated *The Commentary is somewhat different from that contained at pages 381 through 427 of the Background Materials on Federal Estate and Gift Taxation dated March 8 1976 which was prepared by the Staff of the Committee on Ways and Means for the use of the Committee PAGENO="0070" 56 3, ~ - the imposition of an ad4itignal, or ~ppreciat±on, estate tax (AET) on net appreciation 1nc~.u4e4 In a decedent's estate at a flat rate which would reflect the highest long term nap~tal gains tax rate and the highest estate tax race, The AET race would be ~.4% based upon a 35% capital gains tax rate and a 60% estate tax rate, 4, Generacic~~-sIcippi'~ - t~e imposition of a transfer tax upon the termination of a limited trust interest by ~~e~t~ng the trust property as having been transferred by the beneficiary of uch limited interest when the dispoiition of income and principal after such termination does not meet certain requirements, In general, shifts of bepeficial interests among the "family" of the person creating the cret would be exempted from the tax. The term "family" includes ancestors, spouse, children and grandchildren, but not great grandchildren, 5. Unification f or the purpose of determining the rate of tax applicable to transfers at death, transfers during life would be treated as death transfers. 6, Marital Deduction the amount of the marital deduction would be increased to the greater of $250,000 or one-half of the decedent's gross estate, plus certain employment benefits. Since our testimony before this Committee in 1973 we have received comments from individuals and groups regarding some of the alternatives suggested in the ABA Draft Statute. Some of the comments suggest to us that there is a misèon- ception as to the purpose of the Draft Statute. As previously mentioned, it is intended to address itself to each of the major issues and to present solutions representing reasonable compromises of toe conflicting positions. Thus, the ABA suggested the form change should take if a change were to be made in currant law. The most controversial part of the Draft Statute has been the AET. Individuals and organizations have objected to (1) any change in current law, (2) the "imperfect" nature of the AET, and (3) its application to charitable PAGENO="0071" 57 transfers. We would like to respond to these criticisms. The ABA does not favor the enactment of the AET. In his 1973 testimony before this Committee, Stetson B. Harman, the then President of the Trust Division of the ABA, said: "In concluding my comments on the basis `issue, I want to reiterate our opposition to any change in current law. We do not favor the enactment of the AET even if coupled with a deduction in the basic estate tax. Rather, we simply regard the ART as preferable to Carryover or the Capital Gains Tax." This is still our position. We urge this Committee to retain the present income tax basis rule because current law provides a better balance between fairness and simplicity than would any change which has been suggested, including the ART. Unrealized appreciation is usually a significant part of any gross estate in excess of $200,000. We regard any change which imposes a tax on unrealized appreciation either at death or at a subsequent time upon sale as a fruitless exercise. It would make the administration of a decedent's estate substantidily more complex, particularly in the case of assets which are difficult to value. The problems that exist today in arriving at fair values in the negotiating process with the Internal Revenue Service are substantial. They will become more difficult if the basis rule is changed and there is a dual incentive for the Service to assert higher values. In our opinion, the real loser. from any such chaoge would not be the large estate which has the wherewithal to protect itself, but rather the medium size estate. In general the criticisms of the nature of the ART have been made by advocates of a capital gains tax at death and have focused on its failure to produce the same tax result which would have occurred if the decedeot had sold PAGENO="0072" 58 all of his property the day before his death. The AET was specifically designed to avoid this result, which, in our opinion, would have created a disproportionately heavy impact on smaller and medium size estates. This results because the capital gains tax is a debt and thus a deduction in computing a decedent s taxable estate The deduction is more valuable and saves more tax to a larger estate that is in a higher marginal rate of tax. The ABA rejects the concept of parity of treatment between a lifetime sale and a constructive sale at death when the result is to tax smaller estates more heavily than larger estates. Logical symmetry should be disregarded when the result upon affected estates is upside down. The ABA is interested in the "bottom line" tax effect. The AET, a relatively low flat rate of tax on unrealized appreciation at death, produces a more desirable result than a capital gains tax at death for the small and medium size estate. Also, it is unrealistic and naive to believe that creating a parity of treatment with lifetime sales will reduce "lock in" - the failure to sell during life to avoid a substantial capital gains tax. "Lock in" will be reduced significantly only if a substantial tax incentive for lifetime sales is created. Finally, we would emphasize that the AET is the simplest and most straightforward change that has been suggested. In this respect it takes a back seat only to current law. Regarding the application of the AET to charitable transfers, proposals for reducing the unlimited estate tax charitable deduction were made before 1973 and continue to be made. On the other hand, the needs of charities, and particularly public charities such as educational institutions and hospitals, have become greater during the past few years. To a substantial degree they are dependent upon transfers at death for support. PAGENO="0073" 59 We still believe it accomplishes this objective better than any other approach which has been suggested including the one recommended by the AICPA Changes in areas other than those discussed in the Commentary are needed and are included in the Draft Statute We would like to refer specifically to six suggested changes whose importance has increased as a result of developments which have occurred since 1973 and one area in which change has been recommended by the General Accounting Office but where in our opinion current law should be continued. 1. Joint Property Section 2040, applying a consideration in money or money's worth test to the taxation of joint interests in property, has not worked well. In the first place, the problem of proving consideration when the property has been held for a number of years is difficult. More importantly, this test, is inconsistent with the concept that each spouse contributes equally to the marriage Section 2042 has been referred to as a widow s tax See Con- gressional Record, February 18, 1976. S.1862. The problem is partIcularly significant in the case of residences and farms, which are often held in joint names. The widow does not understand why the full value of this property should be included in her husband's estate upon his death when she regards her contribution to the family as being just as important as his There is no completely satisfactory solution to this problem but we do feel that the changes recommended in Sections 6 and 24 of the Draft Statute represent a better approach than existing law. 2 Contemplation of Death Transfers Current law permits tax savings to be achieved by a deliberate PAGENO="0074" 60 transfer made shortly before, and in contemplation of, death because the gift tax both reduces the gross estate and is a credit against the estate tax. A 1975 General Accounting Office Report (GGD-76-l) to the Joint Committee on Internal Revenue Taxation on "Proposed Changes in Estate Taxation" recommended changes in the law to eliminate the tax savings and to improve the operation of the gift tax credit. Section 28 of the Draft Statute also eliminates the tax savings by requiring the gift tax paid to be included as an asset of the decedent's estate for estate tax purposes. The ABA also supports the recommen- dations regarding the computation of the gift tax credit. The ABA believes that the GAO Report does not go far enough in the con- templation of death area. We urge this Committee to eliminate the rebuttable presumption that transfers made within three years of death are "in contem- plation of death" and subs~titute a rule requiring that the gift tax on all transfers made within two years of death be included as an asset of the decedent's estate, as does Section 28 of the Draft Statute. This change would eliminate a source of controversy that exists today regarding the decedent's intent in making transfers within three years of death. 3. Alternate Valuation Date Current law properly permits a decedent's estate having a date of death value of $60,000 or more to be valued as of that date or, generally as of six months after death. The income tax basis for an asset included in a de- cedent's estate is the same as its estate tax value. The alternate valuation method may be used whether or not it results in a lower estate tax. In some cases, particularly with smaller estates, use of this method produces overall tax savings when the estate tax is increased because the higher values for assets which are sold reduce income taxes by more than the estate tax increase. The GAO Report referred to above recommends that use of the alternate PAGENO="0075" 61 valuation method be restricted to cases in which it produces a lower estate tax. The amount of the additional revenue that would result from this change would be small and, as noted in the preceding paragraph, would come largely filom the smaller estates. Current law has the advantages of reducing valuation contro- versies and providing certainty as to the valuation date. Once the estate tax return is filed the choice of valuation date cannot be changed. If the alter- nate valuation method is available only when it results in a lower estate tax, audits of estates with assets difficult to value may necessitate making both valuations to determine which method does in fact produce the lower tax. The ABA regards this dual audit possibility as undesirable and recommends that current law be continued, as does Section 18 of the Draft'Statute. 4. Expenses of Sale Current law regarding the deductibility of expenses of sale under section 2053 is unclear. Circuit courts have reached contrary results. Compare Estate of Park v. Comm'r, 475 F.2d 673 (6th Cir. 1973), with Estate of David Smith v. Comm'r, 510 F.2d 473 (2nd Cir. 1975). The law should be clarified so that all expenses of sale which are allowable under applicable state law are deductible for purposes of section 2053, as is done under Section 29 of the Draft Statute. 5. Life Insurance Current law regarding the tax consequences of the retention of non-beneficial incidents of ownership by a decedent-insured is unclear. Circuit courts have reached contrary results. Compare Rose v. United States, 511 F.2d 259 (5th Cir. 1975) and Terriberry v. United States, 517 F.2d 259 (5th Cir. 1975) with Estate of Skifter v. Comm'r, 468 F.2d 699 (2nd Cir. 1972), and Estate of Fruehauf v. Comm'r, 426 F.2d 80 (6th Cir. 1970). The law should be PAGENO="0076" 62 clarified, as is done under Section 26 of the Draft Statute, to provide that non-beneficial incidents of ownership retained by a decedent-insured do not cause taxation under section 2042. 6. Charitable Remainder Trusts The changes made by the Tax Reform Act of 1969 regarding charitable remainder trusts were undesirable in some respects. The new law has resulted in very complicated regulations and serious problems in drafting trusts that satisfy their requirements. Current law should be changed to return in part to pre-1969 law. Specific recommendations are contained in the Comments (pages 161-66) to Sections 14 and 31 of the Draft Statute. 7. The Gift Tax Annual Exclusion Current law is uncertain in several respects regarding the availability of the exclusion for a trust income interest. Compare Rosen v. Comm'r, 397 F.2d 245 (4th Cir. 1968), with Fred A. Berzon, 63 T.C. 601 (1974), and see Estate of David H. Levine, 63 T.C. 136 (1974), rev'd, 526 F.2d 717 (2d Cir. 1975). The law should be changed to provide that an annual exclusion will be available for a transfer In trust when the donee is the only beneficiary and the trust property would be includible in his gross estate if he died imme- diately after the transfer, as is done in Section 11 of the Draft Statute. PAGENO="0077" 63 AMERICAN BANKERS ASSOCIATION DISCUSSION DRAFT OF TRANSFER TAX STATUTE AND EXPLANATORY COMMENTS PAGENO="0078" 64 Part II. Lifetime Transfers Subpart A Section 3. Section 4. Section 5. Taxable Transfers Certain Property Settlements Transfer by Spouses to Third Party Joint Interests Powers Interest in a Trust or its Equivalent Section 9. Transfers to Which Section 13 Applied Section 10. Transfers tc~ Which Section 15 or 32 Applied Subpart B Section 11. Annual Per-Donee Exclusion TABLE OF CONTENTS Preface Summar~y Detailed Section-by-Section Analysis Part I. Imposition of Tax Section 1. Basic Tax Section 2. Additional Estate Tax Section 6. Section 7. Section 8. 1 14 Statutory Provision Commentary 15 42 18 46 19 70 20 71 20 72 20 72 21 79 21 82 25 117 25 132 25 154 (i) PAGENO="0079" 65 Statutory Provision Commenta~y Section 12. Specific Exemption 26 156 Section 13. Deduction for Certain Transfers 26 117 Section 14. Charitable Deduction 26 158 Section 15. Marital Deduction 26 132 Subpart ç~ Section 16. Disclaimers 28 166 Part III. Transfers at Death Subpart A Section 17. Taxable Transfers 29 170 Section 18. Alternate Valuation 29 170 Section 19. Property in Which Individual Had an Interest 29 171 Section 20. Dower or Curtesy Interests 29 - Section 21. Transfers with Retained Interest 29 117 Section 22. Powers 30 79 Section 23. Employment Benefits 31 172 Section 24. Joint Interests 32 72 Section 25. Interest in a Trust or its Equivalent 32 82 Section 26. Life Insurance 33 175 Section 27. Property to Which Section 15 or 32 Applied 33 `132 Section 28. Transfer Taxes on Lifetime Transfers 34 181 (ii) PAGENO="0080" Disbursements Losses Charitable Deduction Marital Deduction Previously Taxed Property Credit for Transfers at Death Credit for Transfer Taxes Previously Paid 36. Credit for State Death Taxes 37. Credit for Death Taxes on Remainders Section 38. Credit for Foreign Death Taxes Part IV. Miscellaneous Provisions Section 39. Liability for Payment Section 40. Recovery of Taxes Claimed as Credit Section 41. Definition of Executor Section 42. Discharge of Fiduciary from Personal Liability Section 43. Reimbursement Out of Estate Section 44. Apportionment of Tax Section 45. Missionaries in Foreign Service 66 Subpart B Section 29. Section 30. Section 31. Section 32. Section 33. Section 34. Section 35. Section Section Statutory Provision 34 35 35 35 39 39 40 40 40 40 40 40 40 40 40 40 41 Commentary 184 158 132 187 156 190 191 (iii) PAGENO="0081" 67 Statutory Provision Commentary Section 46 Members of the Armed Forces Dying During an Induction Period 41 Section 47. Certain Residents of Possessions Considered Citizens of the United States 41 Section 48 Certain Residents of Possessions Considered Nonresidents Not Citizens of the United States 41 Recommendations Concerning Payment of the Transfer Tax - The "Liguid~y Problem" 194 Cross Reference Tables 202 (iv) 688720 76 6 PAGENO="0082" 68 PREFACE The Tax Reform Act of 1969 hearings before the Ways and Means Committee included testimony concerning revision of the estate and gift tax laws and a change in the current income tax basis rule for property transferred at death. Due to a lack of time, the 1969 Act did not deal with these subjects. Representative Wilbur D. Mills, Chairman of the Ways and Means Committee, did, however, announce his intention of having the committee consider these subjects in the future. During the last three years the Trust Division of the American Bankers Association has had the estate and gift tax laws and a change in the basis rule under continuing study. The members of the Trust Division would prefer to avoid substantial changes in these areas where stability, certainty and simplicity are primary objectives. Nevertheless, change appears likely and they desire to participate in the process of shaping it. The Trust Division has developed what it regards as a constructive program for change in the estate and gift tax laws and the basis rule that responds in every major area to the criticisms of current law. This program is set forth in the discussion draft (the "Draft') of statutory provisions and explanatory comments (the "Commentary") that follow. Preparation of the Draft was found necessary since in some areas - for example the taxation of limited trust interests - policy decisions could not finally be made without a proposed statutory pro- vision. On balance, the Draft does not simplify current law. The additional complexity is required in order to respond to the criticisms of this law. The Draft is based upon our belief that the present level of estate.and gift taxation (estimated in the Economic Report of the President, January, 1973, at $4.6 billion for fiscal 1973 and $5.0 billion for fiscal 1974) is appropriate, and has the effect of reallocating the amount of tax payable by affected taxpayers but does not significantly increase or decrease the total amount of transfer taxation. The additional revenue derived from some changes would be offset by the decreased revenue that would result from other changes. It is believed that the Draft constitutes a modest tax in- crease in terms of long range tax revenues. Thus, it is true "reform", within the total ambit of all affected taxpayers, rather than a tax increase disguised as reform. (v) PAGENO="0083" 69 The starting point for our review of the current estate and gift tax laws and the basis rule was the work of the American Law Institute and the Treasury Department under the administration of the late President Johnson. The American Law Institute publication, Federal Estate and Gift Taxation, Recommendations of the American Law Institute and Reporters' Studies (1969) (the "ALl Project") contains the resolutions adop~ed by the Institute with explanations and the studies and proposals of the reporters. The Treasury's work Tax Reform Studies and Proposals (1969) (the Studies proposed changes under three main headings: (1) taxation of appreciation at death (2) unlimited marital deduction and unification of the estate and gift taxes, and (3) generation skipping transfers. The Draft accepts some of the ideas of these groups, rejects others and modifies still others. In each instance the Commentary sets forth the basis for our actions. (vi) PAGENO="0084" 70 SUMMARY OF TRANSFER ACT DRAFT STATUTE OF AMERICAN BANKERS ASSOCIATION I. Sections Containing Major Changes in Current Law 1. Section 1. Basic Tax. This section imposes a single, cumulative transfer tax on an individual's taxable transfers of property in place of the current two separate gift and estate taxes. Taxable transfers are defined separately in Sections 3 and 17 for lifetime transfers and transfers at death respectively. The tax is computed in the same manner as the current gift tax viz , by calculating a tax on the individual's total transfers to that time, including the transfers to be taxed, and by then subtracting from this amount the tax on the individual's prior transfers, i.e. those in preceding calendar quarters where a lifetime transfer is involved, or all lifetime transfers if transfers at death are being taxed. The Section 1 rate schedule reduces the current estate tax burden on medium estates by eliminating the rapid and steep progression which is present in the lower brackets. As a result of the inclusion of the Section 2 tax and the single rate structure, it is also possible to lower the Section 1 rates to a maximum of 60% in the top bracket from the current top 77% estate tax rate. 2. Section 2. Additional Tax on Certain Transfers. Section 2 imposes an additional tax (AET) of 11t% upon the net appreciation in an individual's transfers at death. Net appreciation in transfers within two years of death is also subjected to the PET in order to prevent avoidance through transfers shortly before death. Current law would be continued as to the income tax basis of assets included in a decedent's gross estate - this basis would be the value of the asset on the applicable valuation date. In the case of property transferred more than twc years before death, its basis, increased by the Section 1 tax attributable to unrealized appreciation, will be "carried over" to the donee. Net appreciation is determined on an aggregate basis by subtracting the basis of the transferred property from its fair market value. Certain assets are deemed to have a basis for AET purposes equal to their fair market value. These assets are (1) life -1- PAGENO="0085" insurance and annuity contracts (2) any item of tangible personal property held for personal use whose fair market value is $5 000 or less (3) any item of tangible personal property whose fair market value is less than its adjusted basis immediately prior to the transfer and (14) items constituting income in respect of a decedent. The basis for remaining assets is the greater of (i) their adjusted bases or (ii) $100,000 less the amount of the specific exemption under Section 12 (not to exceed $30,000) for transfers made more than two years prior to death. As a result of this "minimum" basis an AET will never be imposed in connection with decedents for whom a transfer tax return for transfers at death will not be required In computing the AET all property acquired before the Draft's effective date will have a basis equal to its fair market value on that date adjusted under the normal rules for subsequent events Section 2 contains a special rule for a surviving spouse's share of community property. The spouse may elect (1) to have her share of community property owned at death subjected to a 114% AET in which case the basis of this share will be increased to its value on the applicable valuation date, or (2) to use a carryover basis for her share No exemption from the AE~T is provided for net appreciation in property qualifying for the marital or charitable deduction However the impact of the AET on charitable transfers is lessened by permitting the computation of the allowable charitable deduction for purposes of the Section 1 tax without reduction for the AET and by excldding from inclusion in a decedent's transfers at death any transfer made during life that is wholly charitable at death. 71 3. Sections 8 and 25. Transfers in Trust. Sections 8 and 25 restrict the time during which property may be held in trust and successive beneficial interests given to several generations without having the property subjected to transfer tax Generally speaking these sections are directed at long-term trusts that continue after the death of the transferor's children without the trust property being vested in his grandchildren for transfer tax purposes They do not affect normal types of trust dispositions for a person's "family", viz., his children and grandchildren The general rule, set forth in subsection (a),is -2- PAGENO="0086" 72 that the value of property passing to a beneficiary's descendants upon a termination or distribution is considered as a transfer by the beneficiary for transfer tax purposes. The general rule is not applied to excluded transfers, as described in subsection (c)(8). Any tax payable is to be determined by inclusion of the trust property in the transfers of the beneficiary and is to be paid out of the property subject to tax at the marginal rate or rates of tax. Key words, "beneficiary", "value of property passing to a beneficiary's descendants", "termination" and "distribution", are given their common meanings (subsection (c)) except that a distribution does not include a transfer of current income. A special provision, subsection (d), that treats a person receiving property as having made a transfer of such property is directed at infrequent situations and assures that Sections 8 and 25 cannot be avoided by making unnatural dispositions of trust property. There are two excluded transfer provisions, one for terminations and one for distributions. An outright distribution to a child or grandchild of the person who created the trust is an excluded transfer, as is a distribution in further trust for a grandchild if the trust property is "vested" in the grandchild for transfer tax purposes unless he dies under the a~e of 35 years. Any termination prior to the death of the last survivor of the children of the transferor who are trust beneficiaries is an excluded transfer. LI. Sections 9, 13, 21, 28 and 35. Time Transfer is Taxed,Adjustments and Credits. Section 21, which replaces sections 2036 through 2038, continues the "hard-to-complete" approach regarding the timing of the tax on transfers under which the transferor retains an economic interest in the transferred property or control over it. Section 13 classifies transfers as incomplete to the extent that the value of the transferred property would be included under Section 21 in the individual's transfers at death if he were to die immediately after the transfer. Section 9 makes a prior transfer taxable upon the occurrence of any event which removes the transfer from the protection of Section 13. Sections 28 and 35 provide adjustments for property taxed at death under Section 21 which had been -3- PAGENO="0087" 73 subjected to tax upon its original transfer or was thereafter taxed under Section 9, This can occur where the transferor retains a contingent interest and all preceding interests in others terminate prior to his death. Section 28 includes in transfers at death an amount equal to the transfer taxes previously paid; Section 35 allows a credit in the amount of such transfer taxes against the Section 1 tax. Section 28, independently of its interaction with Sections 9, 13, 21 and 35, requires inclusion in transfers at death of an amount equal to the transfer taxes paid on transfers made within two years of death. Thus such transfers will not give rise, as do transfers "in contemplation of death" under current law, to tax savings in an amount equal to the estate tax on the gift tax. 5. Sections 10, 15, 27 and 32. Marital Deduction. These sections replace sections 2056 and 2523 and make quantitative and qualitative changes in th~ marital deduction, As to quantity, a deduction 1.s permitted for the greater of $250,000 or one-half of the individual's "adjusted transfers", The percentage limitation is applied against the aggregate of the individual's transfers, as under the current estate tax, rather than against the amount of current transfers to his spouse, the gift tax approach. The term "adjusted transfers" means the aggregate of the individual's transfers after the Draft's effective date (reduced by available annual exclusions but not by the amount of the specific exemption and, in the case of transfers at death, by the Section 29 and 30 deductions). A special rule is provided for community property to allow the transferor a fixed dollar deduction equivalent to the $250,000 maximum for non-community property. If information needed to properly compute the deduction is not available, the deduction is limited to 50% of transfers within the calendar quarter (if a lifetime transfer is involved) or of the transfers at death; in the case of converted community property, no deduction is permitted. In computing the deduction for transfers at death, certain employment benefits, including up to $50,000 in group life insurance proceeds, are allowed as additional deductions, As to quality, Sections 15 and 32 permit transfers in which the spouse has only a current beneficial -4- PAGENO="0088" 74 interest to qualify for a deduction. A current beneficial interest is defined as a right for life commencing as of the date of transfer (i) to all the income from property or from a specific portion thereof, payable not less frequently than annually, or (ii) to the use of property or a specific portion thereof. An "income" interest in a charitable remainder trust, or an annuity, is treated as a right to receive income. The transferor may elect (by will in the case of transfers at death) to subject to tax property which otherwise would qualify for the marital deduction In all other respects Sections 15 and 32 are mandatory in application. Sections 10 and 27 provide for the inclusion in the donee spouse's transfers, at a time no later than her death, of property for which a marital deduction was previously allowed. They are necessary because the term "current beneficial interest" includes interests, such as an income interest, which will not be taxed under any other section of the Draft upon their termination. 6. Section 26. Life Insurance. This section continues current law (section 20~l2) as to life insurance other than group term insurance -- the proceeds of such policies will be included in the insured's transfers at death if they are receivable by his estate or if he held at his death an incident of ownership in the policies. The term "incidents of ownership" excludes any non-beneficial right or power held by the insured which he may exercise only in a fiduciary capacity. That part of section 20~42, treating a reversionary interest in a policy as an incident of ownership ~.f its value exceeds 5% of the policy's value immediately prior to the death of the insured, is eliminated. Section 26 changes current law regarding group term life insurance by requiring the inclusion of such insurance in the insured's transfers at death, irrespective of whether the insured retains any incidents of ownership in the policy. In order to avoid the possibility of achieving substantial transfer tax savings by transfers made "in contemplation of death", Section 2 applies the AET to transfers made within two years of death and Section 28 -5- PAGENO="0089" 75 requires inclusion in transfers at death of the transfer taxes paid on transfers made within two years of death Section 26 also contains a two year rule requiring that if an insurance policy is transferred within two years of death an additional amount shall be included in transfers at death equal to the difference between the proceeds and the value taxed on the lifetime transfer. 7. Section 314, Credit for Transfers at Death. This section replaces the current $60,000 exemption, which operates as a deduction, with a credit not to exceed the amount of the tax, of $10,000 (the transfer tax on taxable transfers of $100,000) reduced by 10%. of the amount claimed in computing the transfer tax on lifetime transfers as an exemption under Section 12 or prior law. II Sections Containing Non-Major Changes in Current Law Sections 3 and 17 Taxable Transfers Section 3 combines sections 2503(a) and 2512(b) and provides in a single section for the treatment of full or partial consideration in lifetime transfers The uncertainty that exists under present law concerning the effect of a promise to make a gift is eliminated by stating that such a promise is not a transfer for transfer tax purposes. Section 17 combines sections 2031(a), 20143(a) and 2051 and also provides for the treatment of full or partial consideration in transfers at death 2 Section !I Certain Property Settlements This section continues section 2516 which treats certain transfers in settlement of marital rights and for the support of minor children as made for full consideration, except that the requirement of a divorce within two years of the written agreement is eliminated and in the case of transfers between the spouses a requirement is substituted that the spouses live apart continuously for at least two years after the transfer or until the sooner death of either spouse 3 Sections 6 and 214 Joint Interests Under current law (section 2515), the creation of a joint tenacy or a tenancy by the entirety in real -6- PAGENO="0090" 76 property is not a completed gift when made unless the transferor elects to have it treated as such; in all other cases the creation of a joint tenancy with another person is a completed gift of a part of the value of the property, except when the transferor can regain the entire property without the consent of the other tenant. Section 2O~IO includes in the gross estate of a joint tenant or tenant by the entirety the full value of the property, reduced only by the amount shown to have originated with the other tenant. Sections 6 and 2L1 modify current law and provide that (1) the creation of joint interests (including a tenancy by the entirety) in the transferor and another is a transfer to the extent of the value of the interest controlled by the transferor immediately thereafter (Section 6), and (2) the death of a joint tenant is treated as a transfer of his proportionate share of the property's value (Section 2k). Section 2~4 also provides that upon the death of a joint tenant who could reacquire the entire amount involved, the amount taxed will be based on the percentage of the total consideration which he contributed to the joint interests; to this extent the "consideration- contributed" test of section 20~4O is continued. Similarly, under Section 6, as under current law, no transfer occurs upon the creation of or an additon to a joint interest, such as a joint bank account, in which the contributor may thereafter withdraw his entire contribution. Sections 7 and 22. Powers. These sections make limited changes in sections 201t1 and 251~~. The references in sections 20~1(a)(2) and 251)4(b) to disclaimers and renunciations are eliminated because of the inclusion in Section 16 of a general disclaimer provision. The definition of a general power of appointment is broadened in both sections to include a power created after the Draft's effective date which is limited by an ascertainable standard. The rule relating to the tax treatment of the lapse of a power has been modified so that if more than the greater of $5,000 or 5% of the trust corpus is subject to the power, the entire amount as to which the power is not exercised is treated as a release. Finally, a new subsection (c) is included in Section 22 to insulate from tax at death any amount which was previously taxed as an exercise of, or a release of, a power under Section 7 and which would otherwise be -7- PAGENO="0091" 77 taxable under Section 22(a)(2)(ii) as a lifetime transfer to which Section 21 would have been applicable had the powerholder been the transferor. 5. Section 11. Annual Exclusion. This section replaces subsections (b) and (c) of section 2503. It continues the $3,000. per donee arzriual exclusion but limits its availability to an outz~ight transfer or a transfer in trust where the donee is the only beneficiary and the property is includible in his transfers at death if he dies immediately after the transfer. 6. Sections 1~4 and 31. Charitable Deduction. While these sections continue sections 2055 and 2522, changes are proposed in the related area of section 66~ concerning charitable remainder trusts. See Part IV, item 1. Also, a lowering of the present 6% unrealistic rate of return used by the Treasury tables to ~ 1/2% is suggested. Section 31 modifies section 2055(c) to require a reduction in the allowable charitable deduction only for taxes imposed under the basic tax of Section 1 the deduction is not reduced by reason of a payment of the Section 2 tax from a charitable bequest. 7. Section 16. Disclaimers. Section 16 establishes the requirements of an effective disclaimer for transfer tax purposes. It must be an "irrevocable and unqualified refusal in accordance with local law" to accept the rejected interest which is made within nine months after the interest becomes indefeasibly fixed and before amy benefits have been accepted from it. This test liberalizes current law under which a disclaimer will be effective only if the interest is rejected within a reasonable time after the individual learns of its existence, which in the case of a future interest may be long before it becomes indefeasibly fixed. 8. Section 18. Alternate Valuation. This section modifies section 2032 in providing that a distribution by an executor or trustee to a beneficiary will not "fix" the alternate valuation date for the transferred property unless the distribution gives rise to the recognition of gain or loss to the estate or trust. -8- PAGENO="0092" 78 9. Section 19. Property in Which Individual Had an Interest. Section 2033 is revised to exclude an interest in property which the individual transfers prior to his death unless the interest is certain to become possessory. 10. Section 23. Employment Benefits. This section requires the inclusion of employment benefits in an employee's transfers at death and thereby eliminates the section 2039(c) exclusion. The term "employment benefits" is defined broadly, thus causing Section 23 to be broader than section 2039. Life insurance on the employee's life is not covered by Section 23 but rather by Section 26. Section 23 is not applicable to amounts receivable under the Social Security laws and the laws relating to retired railraod employees. 11. Section 29. Disbursements. This section continues section 2053 except that (i) the deduction for claims is liberalized to cover all claims against property included in transfers at death or in transfers made within two years of death that are paid, regardless of the time of payment, and (ii) all expenses of sale that are proper adxninistra- tion expenses are deductible, regardless of the purpose of the sale, except for those relating to property not subject to claims that are paid after the period for assessing the transfer tax. Also, a new provision is added to make it clear that amounts payable under a divorce or separation decree or under a written agreement incident to a divorce or separation are allowable deductions so long as the spouses live apart continuously thereafter. 12. Section 33. Previously Taxed Property. Where the transferee dies within a ten-year period after the receipt of property this section replaces the credit of section 2013 with a deduction. A full deduction is available if the second inclusion follows the first by six years or less, and the allowable amount decreases by 25% for each year thereafter. A further limitation provides that no deduction is available for an interest in a trust unless the trust property is included in the individual's transfers at death. -9- PAGENO="0093" 79 13 Section 414 Apportionment of Tax This section replaces sections 2206 and 2207 and provides rules for the apportionment of the Section 1 and Section 2 taxes to non-testamentary property included in an individual's transfers. A pro rata allocation of the Section 1 tax is used for property included in transfers at death under the provision relating to powers, joint interests and amounts paid as transfer taxes (Sections 22, 26 and 28, respectively). The Section 1 tax to be apportioned for property included in transfers at death under Section 25 or Section 27 relating to "generation-skipping" transfers and property not otherwise includible for which a marital deduction was previously allowed, is based upon the individual's highest marginal rates of transfer tax. The Section 2 tax is allocated to the property containing net appreciation on a pro rata basis using the ratio of its net appreciation to total net appreciation. III. Sections in Which Current Law is Continued Unchanged 1. Section 5. Transfer by a Husband or Wife to Third Party. - continues §2513. 2. Section 12. Specific Exemption. - continues §2521. 3. Section 20. Dower or Curtesy Interests, - continues §20314. 4. Section 30. Losses. - continues §20514. 5. Section 36. Credit for State Death Taxes, - continues §2011, with appropriate adjustments in rates. 6. Section 37. Credit for Death Taxes on Remainder. - continues §2015. 7. Section 38. Credit for Foreign Death Taxes. - continues §2014. 8. Section 39. Liability for Payment. - continues §~2o22 2502(d) 9 Section 40 Recovery of Taxes Claimed as Credit - continues ~2016 10 Section 41 Definition of Executor - continues §2203 -10- PAGENO="0094" 80 11. Section 42. Discharge of Fiduciary from Personal Liability. - continues §2204. 12. Section 43. Reimbursement Out of Estate. - continues §2205. 13. Section 45. Missionaries in Foreign Service. continues §2202. 14. Section 46. Members of the Armed Forces Dying During an Induction Period. - continues §2201. 15. Section 47. Certain Residents of Possessions Considered Citizens of the United States. - continues §~22O8., 2501(b). 16. Section 48. Certain Residents of Possessions Considered Nonresidents Not Citizens of the United States. - continues §~2209, 2501(o). IV. S~ggested Changes in Related Areas A. Miscellaneous 1. Section 664 The definition of a charitable remainder "income" unitrust contained in section 664(d)(3) should be modified (i) to base the "income" limitation upon the rate of return used in the Treasury Tables to value the charitable interest on the original transfer, which is currently 6%, rather than 5%, and (ii) to permit a payout, pursuant to the exercise of a general power of appointment held by a recipient, of the amount by which all payments to the recipients are less than the aggregate projected annual return for the years from the commencement of the trust under that rate of return in the Treasury Tables. See pages 162-66. 2. Section 678 This section should be changed to provide that a person (other than the grantor) is not to be treated as the owner of trust property as a result of a power of withdrawal if the trust income is currently distributable to such person and the amount subject to the power does not exceed the greater of $5,000 or 5% of the trust property. See pages 81-82. -11- PAGENO="0095" 81 B. Payment of Tax The suggestions for changes which are summarized below are discussed in a separate section of the Commentary beginning on page 1914. 1. Section 6601(b) This section should be changed to delete the special 14% rate of interest for certain deferred estate tax payments. This change should remove the only sound reason for rejecting the substantial liberalizations of the liquidity provisions referred to in items 2 through 6. 2. Section 6165 This section should be amended to substitute the use of security arrangements for bonds where the time for payment of the tax has been extended. If this change is made, section 22014 should be modified to release a fiduciary from personal liability upon payment of the tax currently due and execution of a security arrangement satisfying the provisions of section 6165. 3. Section 6166 Several liberalizing changes should be made regarding the circumstances under which payment of the tax may be deferred. Deferral should be permitted in any case where the value of the decedent's interest in a closely held business exceeds 20% of his transfers at death. The definition of a closely held business should be broadened to include, in the case of stock, any stock not traded on a national securities exchange or in an over-the-counter market, or if so traded, 20% or more of the stock and, in the case of a partnership carrying on a trade or business, the required percentage would be reduced from 20 to 10 and the limitation on partners would be increased from 10 to 20. 14. Section 303 This section should be amended to conform its requirements to those of section 6166 discussed above.. It should also be modified (1) to extend the redemption period to 10 years, and (2) to apply the section only to the extent the redeeming shareholder is liable for the payment of death taxes or funeral or administration expenses. -12- PAGENO="0096" 82 5. Section 6161(a)(2) This provision, permitting the period of time to pay the tax to be extended for a reasonable period not to exceed 10 years in the case of "undue hardship" to the estate, should be changed to eliminate the word "undue". 6. Section 6163(a) This section, granting an extension of tine for the payment of tax on a reversionary or remainder interest in property, should be broadened to permit a deferral of the tax on any asset which is not received by a fiduciary or a beneficiary within 15 months of the decedent's death. -13- PAGENO="0097" 83 CHAPTER X TRANSFER TAX PART I Imposition of Tax Section 1. Basic Tax Section 2. Additional Tax on Certain Transfers PART II. Transfers Other Than at Death (Lifetine Transfers). Subpart A. Provisions Relating to Includibility -- Section 3. Section 4~ Section 5. Section 6. Section 7. Section 8. Section 9. Section 10. Subpart B. Taxable Transfers Certain Property Settlements Transfer by a Husband or Wife to Third Party Joint Interests Powers Interest in a Trust or its Equivalent Transfers to Which Section 13 Applied Transfers to Which Section 15 or 32 Applied Exclusion and Deductions -- Section 11 Annual Per-.Donee Exclusion Section 12 Specific Exemption Section 13 Deduction for Certain Transfers Treated as Transfers at Death Section 1L~ Charitable Deduction Section 15. Marital Deduction Subpart C. Disclaimers -~ Section 16 Disclaimers PART III Transfers at Death Subpart A Provisions Relating to Includibility -- Section 17 Taxable Transfers Section 18 Alternate Valuation Section 19 Property in Which Individual Had an Interest Section 20 Dower or Curtesy Interests -14- 68-872 0 - 76 - 7 PAGENO="0098" Sub~part B. Transfers With Retained Interest Powers Employment Benefits Joint Interests Interest in a Trust or its Equivalent Life Insurance Property to Which Section 15 or 32 Applied Transfer Taxes Paid on Transfers Other Than at Death Deductions and Credits -- Section 29. Section 30.. Section 31. Section 32. Section 33. Section 34. Section 35. Section 36. Section 37. Section 38. Section 39. Section 40. Section 41. Section 42. Section 43. Section 44. Section 45. Section 46. Section 47. 48. Disbursements Losses Charitable Deduction Marital Deduction Previously Taxed Property Credit for Transfers at Death Credit for Transfer Taxes Previously Paid Credit for State Death Taxes Credit for Death Taxes on Remainders Credit for Foreign Death Taxes PART IV. Miscellaneous Provisions Liability for Payment Recovery of Taxes Claimed as Credit Definition of Executor Discharge of Fiduciary From Personal Liability Reimbursement Out of Estate Apportionment of Tax Missionaries in Foreign Service Members of the Armed Forces Dying During an Induction Period Certain Residents of Possessions Considered Citizens of the United States Certain Residents of Possessions Considered Nonresidents Not Citizens of the United States Section 1. Basic Tax. (a) Imposition of Tax. - A tax, computed as provided in subsection (b), is hereby imposed on the taxable transfers by a citizen or resident of the United States of property, real or personal, tangible or intangible, wherever situated. The term taxable transfers" means (i) for transfers 84 Section 21. Section 22. Section 23. Section 24. Section 25. Section 26. Section 27. Section 28. -15- PAGENO="0099" 85 other than at death, the taxable transfers as defined in section 3, and (ii) for transfers at death, the taxable transfers as defined in section 17. (b) Computation of Tax. - The tax imposed by subsection (a) of this section shall be an amount equal to the excess of - (1) For transfers other than at death - (i) a tax, computed in accordance with the rate schedule set forth in this subsection, on the aggregate sum of the taxable transfers for the calendar quarter and for all preceding calendar quarters subsequent to 197 3, over (ii) a tax, computed in accordance with such rate schedule, on the aggregate sum of the taxable transfers for all such preceding calendar quarters. (2) For transfers at death - (i) a tax, computed in accordance with the rate schedule set forth in this subsection, on the aggregate sum of the taxable transfers at death and the taxable transfers other than at death for all calendar quarters subsequent to [ , 197 3, over (ii) a tax, computed in accordance with such rate schedule, on the aggregate sum of the taxable transfers other than at death for all calendar quarters subsequent to [ , 197 3. Rate Schedule If the amount of taxable transfers is: The tax shall be: Not over $150,000 10% of such amount. Qver $150,000 but not over $200,000 $15,000, plus 12% of excess over $150,000. Over $200,000 but not over $300 000 $21 000 plus 1~4% of excess over $200,000. Over $300,000 but not over $1400,000 $35,000, plus 17% of excess over $300,000. Over $~40O,0O0 but not over $500,000 $52,000, plus 20% of excess over $LlO0,000. -16- PAGENO="0100" Over $500,000 but not over $700,000 Over $700,000. .but not over $1,000,000 Over $1,000,000 but over $1,500,000 Over $1,500,000 but over $2,000,000 Over $2,000,000 but over $2,500,000 Over $2,500,000 but over $3,000,000 Over $3,000,000 but over $3,500,000 Over $3,500,000 but over $)4,000,000 Over $14,000,000 but over $5,000,000 Over $5,000,000 but over $6,000,000 Over $6,000,000 but over $7,000,000 Over $7,000,000 but over $8,000,000 $72,000, plus 23% of excess over $500,000. $118,000, plus 26% of excess over $700,000. $196,000, plus 30% of excess over $1,000,000. $346,000, plus 33% of excess over $1,500,000. $511,000, plus 36% of excess over $2,000,000. $691,000, plus 39% of excess over $2,500,000. $886,000, plus 42% of excess over $3,000,000. $1,096,000, plus 145% of excess over $3,500,000. $1,321,000, plus 48% of excess over $4,000,000. $1,801,000, plus 50% of excess over $5,000,000. $2,301,000, plus 52% of excess over $6,000,000. $2,821,000, plus 54% of excess over $7,000,000. $3,361,000, plus 56% of excess over $8,000,000, 86 not not not not not not not not not not Over $8,000,000 but not - over $9,000,000 -17- PAGENO="0101" 87 Over $9,000,000 but not over $10,000,000 . $3,921,000, plus 58% of excess over $9,000,000. Over $10,000,000 $t~,SO1,OOO, plus 60% of excess over $10,000,000. Section 2. Additional Tax on Certain Transfers. (a)(1) Imposition of Tax. - An additional tax of iLl percent is hereby imposed on the net appreciation in the value of the property transferred by a citizen or resident of the United States at death, or within a period of two years ending with the date of hIs death to the extent that the property so transferred has not been disposed of prior to his death in a transaction which results in the recognition in full of gain or loss. The term "net appreciation' shall mean the excess of (1) the fair market value of all property so transferred (as determined for purposes of imposing the tax under section 1) over (ii) the basis of such property. (2) Spouse's Election Concerning Community Property. (A) General Rule. - For purposes of this section, and subject to the provisions of subparagraph (B), the surviving spouse of a citizen or resident of the United States may elect to have his or her share of community property (held as of the date of the deceased spouse's death) treated as property transferred under this section 2 with a basis as provided in paragraph (b)(2) and subject to an additional tax of iLl percent on the net appreciation in such share determined as of the date of death or the alternate valuation date, as the case may be, used in valuing the transfers at death of the deceased spouse. (B) Method of Election. - An election pursuant to subparagraph (A) may be made at or prior to the date on which the return with respect to the deceased spouse's transfers at death is filed. (C) Liability for Tax. - The tax imposed under this section upon property with respect to which an election is made pursuant to this paragraph (2) shall be charged to the surviving spouse's share of the community property. (b)(1) Basis, In Gefleral. - For purposes of this section and except as provided otherwise in this subsection or in subsection (d), the basis of property shall be the fair market value on the applicable valuation date of all property enumerated in subsection (c) and the greater of (i) the basis (adjusted as provided in section 1016) of all other property or (ii) $100,000 reduced by the aggregate of -18- PAGENO="0102" 88 the amounts previously allowed to the individual as a deduction pursuant to section 12 for, transfers made more than two years prior to such individual's death. (2) Basis, Surviving Spouse's Share of Community Property. - For purposes of this section and except as provided in subsections (c) and (d), the basis of the surviving spouse's share of community property shall be the basis (adjusted as provided in section 1016) of the surviving spouse as to such property. (3) Certain Charitable Transfers. - For purposes of this section, the basis of property transferred to or belonging to a pooled income fund (as described in section 642(c)(5)) or to a charitable remainder trust (as described in section 664) shall be the basis of the property originally transferred by the individual to such fund or trust immediately after the transfer increased, in the case of a transfer to a charitable remainder trust, by the aggregate amount that is considered as a provided in section 664(b) (2). (c) Assets Having a Basis Equal to Fair Market Value. - The property enumerated below shall be deemed to have a' basis equal to its fair market value on the applicable valuation date: (1) life insurance contracts. (2) annuity contracts. (3) income in respect of a decedent, including pension and profit sharing benefits. (14) any item of tangible personal property held for personal use provided that its fair market value does not exceed $5,000. (5) any other item of tangible personal property having a fair market value less than its adjusted basis immediately before the transfer. (6) cash. For purposes of this subsection, items normally sold as a set or collection shall be treated as a single item. (d) Property Acquired Before C 197 ]. For purposes of this section, the basis of property (other than property described in subsection (c)) acquired by an individual prior to [ , 197 ] shall be its fai~ market value on C , 197 ], adjusted (as provided in section 1016) for the period after [ 197 ]. Section 3. Ta~cable Transfers. For transfers other than at death, the term "taxable -19- PAGENO="0103" 89 transfers" means the total amount of transfers (exclusive of transfers made for an adequate and full consideration in money or money's worth, and reduced in the case of any other transfer by the amount of consideration received in money or money's worth) during the calendar quarter, reduced by the amount of the exclusion and deductions allowed under subpart B of this part. For purposes of this section, a promise to make a lifetime transfer, whether or not enforceable under local law, shall not be deemed a transfer. Section J4~ Certain Property Settlements. Where husband and wife enter into a written agreement relative to their marital and property rights, any transfers made pursuant to such agreement - (1) to either spouse in settlement of his or her marital or property rights, or (2) to provide a reasonable allowance for the support of children of the marriage during minority, shall be deemed to be transfers made for an adequate and full consideration in money or money's worth, provided that in the case of a transfer pursuant to (1) the spouses thereafter live apart continuously for at least two years or until the sooner death of either spouse. Section 5. Transfer by a Husband or Wife to Third Party. [Present §2513]. Section 6. Joint Interests. (a) General Rule. - There shall be included in the transfers of an individual, for the calendar quarter within which joint interests in property are created in another person or persons and himself, the excess of his contribution to such interests over the value of his interests immediately after the creation of such interests, unless such individual can regain his entire contribution without the consent of any other person In determining the value of a joint interest in property, each holder of such an interest shall be regarded as owning an equal undivided share of such property, unless his undivided share is deternined by neans of a different proportion under local law. (b) Add±tions. - An additional contribution to joint interests in property shall be regarded as a creation -20- PAGENO="0104" 90 of such interests to the extent of the additional contribution. (c) Definition. - For purposes of this section, the term "Joint interests" means interests in property which are possessed by two or more individuals (1) Jointly with right of survivorship (whether or not such right is considered contingent under local law) or (2) by the entirety. Section 7. Powers. [Present §25U4, reworded to conform, except that (i) subsection (b) will read as follows: "The exercise or release of a general power of appointment created after October 21,19142 shall be deemed a transfer of property by the individual possessing such power." (ii) subsection (c)(1), relating to the exclusion from the category of general powers of appointment- of powers limited by an ascertainable standard, will be deleted with reference to powers created after the effective date of the Draft; and (iii) subsection (e) will read as follows: "The lapse of a power of appointment created after October 21, 19~t2, during the life of the individual possessing the power shall be considered a release of such power. The preceding sentence shall not apply with respect to the lapse of a power during a calendar year if the property which could have been appointed by exercise of such lapsed power did not exceed, at the time of such lapse, the greater of the following amounts: (1) $5,000, or (2) 5 percent of the aggregate value of the assets out of which, or the proceeds of which, the exercise of the lapsed power could be satisfied."] Section 8. Interest In a Trust or its Equivalent. (a) General Rule. - Except as provided in subsection (c)(8) (relating to excluded transfers), there shall be included as a transfer by an individual who is a beneficiary of a trust or its equivalent (to the extent not otherwise treated as a transfer under this part II) the -21- PAGENO="0105" 91 value of property passing to his descendants upon a termination or distribution during his life. (b) Computation and Payment of Tax. The tax payable under this section shall be computedin accordance with the provisions of this chapter and, unless the beneficiary otherwise elects, shall be paid out of the property subject to the tax. Such tax shall be an amount equal to the excess of the tax over the tax computed without including such transfer in the transfers for the period. (c) Definitions. - For purposes of this section and section 25 of this chapter (1) Beneficiary. - The term "beneficiary" means any person (except a transferor or a person who is a successor to a beneficiary by means of an assignment) who, immediately prior to a termination or distribution, is entitled to receive property subject to a transfer in trust or its equivalent or is a permissible recipient of such property pursuant to the exercise of a power held by any person or would be so entitled, or would be a permissible recipient, except for an assignment made by him. (2) Descendant. - The term "des cendant" means issue in any degree of the beneficiary or of any spouse of the beneficiary and any spouse of such issue and includes issue by adoption (provided such issue is not otherwise a descendant of the beneficiary) and any successor to a descendant by means of an assignment. (3) Termination and Distribution. The tern "termination" means any occurrence, other than a distribution, whereby a person who is a beneficiary immediately prior to such occurrence ceases to be a beneficiary. The term "distribution" means any transfer pursuant to the terms of the governing instrument whereby property ceases to be a part of a trust or its equivalent. A payment of current income shall not be considered a "termination" or a "distribution". (Li) Power. - The term "power" means an authority in any person to do any act in relation to a beneficial interest in property, including any authority the exercise of which is limited by a fixed and ascertainable standard but which authority is not presently exercisable by reason of such limitation. (5) Transferor. - The term "transferor" means any person to the extent that property is transferred by him pursuant to the provisons of this chapter. (6) Member of the Same Generation. - The term "member of the same generation" means, in the case of any person who is not a descendant of a grandparent of the transferor, any person who is not more than twenty-five years younger than the transferor, but does not include any -22- PAGENO="0106" 92 .descendant of a beneficiary who is a member of the same generation as the transferor. (7.) Value of Property Passing to a Beneficiary's Descendants. The term "value of property passing. to the beneficiary's descendants" means (A) as to a distribution, the actual value of property so passing; and (B) as to a termination, (i) to the extent that subparagraph (B)(ii) does nOt apply., the value of the property that would be distributed to the descendants of the beneficiary as a final distribution, if the trust became distributable at the termination plus, as to any property that would not be so distributed, the full value thereof to the extent the, descendants of the beneficiary have an interest therein; (ii) if the property is subject to a power that is or may become exercisable after the termination in favor of the beneficiary's descendants, the value of the property that would pass to the descendants if the power were exercisable upon such termination and the beneficiary held the power and exer.cised the power in favor of his descendants, or, if greater, permitted the property subject to the power to pass to the beneficiary's descendants as takers in default of appointment. For purposes of this subparagraph (B), the value of property passing to a descendant shall be reduced by an amount equal to the value of any consideration in money or money's worth received by the beneficiary by reason of any assignment causing the termination and the value, determined at termination, of any income Interest then outstanding in such property of any person other than a descendant of the beneficiary. (C.) In applying subparagraphs (A) and (B), no reduction shall be made for any tax imposed by this chapter. (8) Excluded Transfer. - This section shall not apply to the following: (A) Pre-existing Trust. Property held in trust on ~ , 197 ] until such time as an individual is deemed a transferor with respect to such property. (B) Terminations. (i) Descendants. - A termination prior to the death of the survivor of a class consisting of one or more of the transferor's spouse, any ancestor of the transferor, the PAGENO="0107" 93 transferor's children and their 8POU5~8 if, immediately after the termination, each such person or persons used as a measuring life is a beneficiary and at least one of such persons is used as a measuring life. (ii) Collaterals. - A termination prior to the death of the survivor of a class consisting of one or more of the transferor's spouse, any ancestor of the transferor, the children of a member of the sane generation as the transferor and the spouses of such children if, immediately after the termination, each such person or persons used as a measuring life is a beneficiary and at least one of such persons is used as a measuring life. (C) Distributions. - An outright distribution to a child or grandchild of the transferor or of a member of the sane generation as the transferor. For purposes of this paragraph a disposition shall be deemed to be made outright to a grandchild if it is in trust for such grandchild and (i) no subsequent distribution of property (including current income) may be made other than to such grandchild, except upon his death before attaining the age of 35 years; and (ii) either the property will, no later than such grandchild attaining said age, pass outright to, or be subject to a general power of appointment held by, such grandchild or the property will upon such grandchild's death be distributed to his estate. (a) Recipient Treated as Transferring Property to Himself. - If upon a distribution property is payable to a person who (1) is not an ancestor, child or grandchild of the transferor or of a member of the sane generation as the transferor, or a spouse of any such person, and (2) is not a descendant of an individual who was a beneficiary immediately prior to the distribution, there shall be included in the transfers of such person for the third calendar quarter commencing after the event causing the distribution sixty percent of the value of the property deterniried as of the occurrence of said event. (e) Regulations. - The Secretary or his delegate shall prescribe such regulations as may be necessary to carry out the purposes of this section and section 25. -24- PAGENO="0108" 94 Section 9. Transfers to which Section 13 Applied. If, after a transfer of property by an individual for which a deduction was allowed under section 13, an event occurs by reason of which the property would not be included in his transfers at death upon his death immediately after said event, the individual shall be deemed to have made a transfer of the property upon the occurrence of said event. Section 10. Transfers to Which Section 15 or 32 Applied. If the income from or the use of property for which a deduction was allowed under section 15 or 32 is disposed of by an individual and such disposition effects a termination of his current beneficial interest, the individual shall be deemed to have made a transfer, upon the disposition becoming effective, of the property as to which such termination occurs. For purposes of this section, the value of the right to receive a fixed dollar amount per year shall be that percentage of the property as of the termination of such right which the fixed dollar amount is to the annual net income of the property, as of the date of transfer, computed by use of the rate of return prescribed on such date of transfer for the valuation of interests in transferred property under this chapter. Section 11. Annual Per-Donee Exclusion. In the case of an outright transfer of property to any person during a calendar year, $3,000 of the transfer, less the aggregate amount of transfers to such person during all preceding calendar quarters of the calendar year for which an exclusion under this section is allowable, shall not be included in the total amount of transfers made during the calendar quarter. If property is transferred for which a deduction is allowable under section 15 based upon a percentage of the value of the property transferred such deduction shall be applied prior to the calculation of the amount excludable under this section. As used in this section, the term "outright transfer of property to any person" shall include a transfer in trust or its equivalent if the property would be included under this chapter in the transfers at death of such person upon his death immediately after the transfer and if prior to the death of such person no other person may in any event have a right, or eligibility pursuant to the exercise of a power, to the property or to the income from or the use of the property. -25- PAGENO="0109" 95 Section 12 Specific Exemption There shall be allowed as a deduction an amount equal to $3O~OOO less the aggregate of the amounts allowed as a deduction pursuant to this section and any equivalent provision of prior law with respect to preceding calendar quarters or calendar years commencing after December 31 1931 Section 13. Deduction for Certain Transfers Treated as Transfers at Death There shall be allowed as a deduction the value of property transferred by an individual which would be included under section 21 23 or 26(a)(i) in his transfers at death upon his death immediately after the transfer Section 1~ Charitable Deduction [Present §2522 reworded to conform, except that a new subsection (c)(3) shall be added: "No deduction shall be allowed under this section for an interest in property for which a deduction is allowed under section 15 by reason of the same transfer."] Section 15 Marital Deduction (a) Allowance of Deduction (1)(A) General Rule. - Subject to the limitation of paragraph (2) of this subsection, there shall be allowed as a deduction the value of all property included in an individual's transfers which passes outright to his spouse or in which his spouse possesses a current beneficial interest. (B) Property Formerly~Held as Community Property If after [ 137 ] property held as community property was by an individual and his spouse converted by one transaction or a series of transactions into separate property of such individual and his spouse (including any form of co-ownership by them) a deduction shall be allowed under this section with respect to any property acquired at any time by him in exchange therefor (by one exchange or a series of exchanges) which shall not exceed one-half the -26- PAGENO="0110" 96 excess of $250,000 over the sum of (1) twice the amounts previously allowed as a deduction under this section with respect to transfers of such converted community property, and (ii) all other amounts previously allowed as a deduction under this section. (2) Limitation. - (A) The deduction provided in this section, when added to amounts previously deducted hereunder shall not exceed an amount equal to the greater of $250,000. or one-half of the value of an individual's adjusted transfers. (B) If available records are such that, under regulations prescribed by the Secretary or his delegate, the limitation on the amount of the deduction allowable under this section cannot be computed under subparagraph (A) of this paragraph (2), (i) the deduction allowed under this section shall not exceed one-half the value of the property transferred under this chapter during the calendar quarter, reduced by any amounts applicable thereto for which exclusions are provided in section 11 but not reduced by any anount allowable as a deduction under section 12, and (ii) no deduction shall be permitted under this section for a transfer of property described in subparagraph (B) of paragraph (1) of this subsection. (b) Definitions. - For purposes of this section, (1) Current Beneficial Interest. - (A) the tern "current beneficial interest" means a right for life commencing as of the date of transfer, (i) to all the income from property or all the income from a specific portion thereof, payable annually or at more frequent intervals, or (ii) to the use of property or a specific portion thereof. (B) For purposes of subparagraph (A), (i) a right to receive payments from a chari- table remainder trust (as described in section 661~) shall be considered as a right to all the income from the property held in such trust if the payments described in paragraphs (1), (2) or (3)(A) of section 66~(d) nay be made only to the spouse; and (ii) a right to receive a fixed amount per year shall be considered a right to receive all the income from property or a specific portion of such property. (2) Property Passing Outright. - The term -27- PAGENO="0111" 97 "property . . . which passes outright" includes property (other than property or a specific portion thereof from which payments are to be made pursuant to a right described in paragraph (1)(~)(ii) of this subsectioti) *held as a separate fund, under regulations of the Secretary or his delegate, in which no person other than the spouse or her estate has any beneficial interest except pursuant to the exercise by the spouse of a general power of appointment described in section 22. (3) Adjusted Transfers. - The term "adjusted transfers" means the total value of an individual's transfers for the current calendar quarter and for all preceding calendar quarters subsequent to [ , 197 ], reduced by any amounts applicable thereto for which exclusions are provided in section 11 and by any amounts for which a deduction is or was allowed under section 1k, but not reduced by any amount allowed as a deduction under section 12. For the purposes of this paragraph, a transfer of community property includible in an individual's transfers shall be deemed to be a transfer of the entire community interest of both spouses in the property transferred and the transferred amount shall be the aggregate value of both halves of the community property so transferred. (c) Election. - An individual may elect, in accordance with regulations prescribed by the Secretary or his delegate to have all or any portion of his property to which subsection (a) is applicable treated as property to which said subsection is not applicable Section 16. Disclaimers. (a) General Rule. - If an individual makes a disclaimer, as defined in subsection (b), in whole or in part with respect to an interest in property, he shall not thereby be deemed to have made a ~t-ransfer under this chapter or to have possessed the interest for the purposes of this chapter. (b) Definition. - The t~erm "disclaimer" means the irrevocable and unqualified refusal in accordance with local law to accept, in whole or in part, an interest in property, but only if (i) the refusal is by a written statement, made within 9 months of the interest becoming indefeasibly fixed and filed with the transferor, his legal representative, or the person who holds the legal title to the -28- PAGENO="0112" 98 property to which it relates; and (ii) prior to the refusal, such individual has not waived his right to disclaim, or accepted the interest or its benefits. Section 17. Taxable Transfers. For transfers at death, the term "taxable transfers" means the total value of all transfers (exclusive of transfers made for an adequate and full consideration in money or money's worth and reduced in the case of any other transfer by the amount of consideration received in money or money's worth) to which sections 19 through 28 of this part are applicable, reduced by the amount of the deductions allowed under subpart B of this part. Section 18. Alternate Valuation. [Present §2032 reworded to conforn except that (i) tne words `distributed and distribution will be deleted from subsection (a) wherever they appear, and (ii) the following sentence will be added at the end of subsection (a): `For the purposes of this subsection a distribution to a beneficiary by the executor or a trustee shall not be deemed a sale, exchange or other disposition of property unless gain or loss under subtitle A of this Title is recognized upon the distribution."J Section 19. Property in which Individual Had an Interest. There shall be included in the transfers of an individual at death the value of all prooerty to the extent of his interest therein at his death. This section shall not apply to an individual's interest in property he transferred prior to his death unless such interest is certain to become possessory. Section 20. Dower or Curtesy Interests. [Present §203L4] Section 21. Transfers with Retained Interest. (a) General Rule. - Except as provided in -29- PAGENO="0113" 99 subsection (b) there shall be included in the transfers of an individual at death the value of all property as to which he has made a transfer and has retained until his death (i) a right or eligibility pursuant to the exercise of a power (other than a power taking effect upon the death of the person holding the power) to receive the property or the income from or the use of the property which right or eligibility is not subject to a condition precedent (other than the exercise of such a power) immediately prior to his death or (ii) a power, held in any capacity either alone or in conjunction with any person, to determine the persons (other than ones described in section 31) who shall receive the property, or the income from or the use of the property, or the time at which the property or the income from or the use of the property shall be received by any such person Any right eligibility or power to which this section is applicable shall be deemed to relate first to amounts constituting income from the transferred property notwithstanding any provision of the governing instrument or local law As used in this section, the term "power" means an authority to do any act in relation to a beneficial interest in property, including but not limited to an authority whose exercise is limited by a fixed or ascertain- able standard (whether or not such an authority is exercis- able pursuant to such limitation at the death of the holder thereof) (b) Exception for Certain Charitable Transfers - The transfers of an individual at death shall not incoude the value of any property as to which he has made a transfer to a pooled income fund (as described in section 642(c)(5)) or to a charitable remainder trust (as described in section 66~4) if, after his death no person other than one described in subsection (a) of section 31 has any interest in such property Section 22. Powers. [Present §20141 reworded to conform except that (1) subsection (a)(2) will read as follows: To the extent of any property (i) with respect to -30- 68-872 0 - 76 - 8 PAGENO="0114" 100 which such individual has at his death a general power of appointment created after October 21, 19k2, or (ii) with respect to which he has at any time exercised or released such a power of appointment by a disposition to which section 21 would be applicable at his death if he had been the transferor of such property. For purposes of this paragraph, the power of appointment shall be considered to exist on the date of such individual's death even though (1) the exercise of the power is subject to a precedent giving of notice, whether on or before the date of death notice has been given; or (2) the exercise of the power takes effect only on the expiration of a stated period after its exercise, whether on or before the date of death the power has been exercised." (ii) subsection (b)(1)(A), relating to the exclusion from the category of general powers of appointment of powers limited by an ascertainable standard, will be deleted with reference to powers ôreated after the effective date of the Draft; (iii) subsection (b)(2) will read as follows: "For purposes of this section, the lapse of a power of appointment created after. October 21, 19L~2, during the life of the individual possessing the power shall be deemed a release of such power to the same extent it was so deemed under section 7(e) when it occurred"; and (iv) a new subsection (c) will be added to read as follows: "(c) Special Rule. - In any case to which subsection (a)(2)(ii) applies, the value of property to be included in an individual's transfers at death shall be reduced by the amount of such property previously included in his transfers under section 7." Section 23. Employment Benefits. (a) General Rule. - Except as provided in subsection (b), transfers of an individual at death shall include the value of all amounts receivable other than as insurance on his life by any beneficiary by reason of sur- viving the individual under any form of plan or agreement -31- PAGENO="0115" 101 derived from or connected with the individual's employment at or prior to his death. (b) Exceptions. - Subsection (a) shall not apply to any amount receivable pursuant to (i) subchapter II of chapter 7 of Title 142 of the United States Code (relating to federal old-age, survivors, and disability insurance benefits), or (ii) chapter 9 of Title 145 of said Code (relating to retirement of railroad employees), unless the individual possessed at his death a right to designate the recipient of such amount, or (iii) employer contributions before [ , 197 ]. Section 214.. Joint Interests. (a) General Rule. - There shall be included in the transfers of an individual at death the value of his joint interest, immediately prior to his death, in any property. For purposes of this subsection, each holder of joint interests in property shall be regarded as owning an equal undivided share of such property, unless his undivided share is determined by means of a different proportion under local law. (b) Exception. - In the case of a termination at death of joint interests held by an individual who immediately prior to his death could acquire the entire property subject thereto without the consent of any other person, there shall be included in the transfers of the individual at death that part of the value of such property which bears the same proportion to the total value of such interests as the consideration in money or money's worth furnished by the individual bore to the total value of all consideration furnished for such property. (c) Definition. - For purposes of this section, the term "joint interests" shall have the meaning prescribed for that term in section 6(c) of this chapter. Section 25. Interest in a Trust or its EquivaLent. Except as provided in subsection (c)(8) of section 8 of this chapter (relating to excluded transfers), there shall be included in the transfers at death of an individual who is a beneficiary of a trust or its equivalent (to the extent not otherwise treated as a transfer at death) `the value of property passing to his descendants upon a -32- PAGENO="0116" 102 termination or distribution occurring upon his death. Section 26 Life Insurance (a) General Rule. There shall be included in the transfers of an individual at death the value of all property - (i.) Group term life insurance. - To the extent of the amount receivable as group tern insurance under policies on the life of the individual, by any beneficiary other than a present or former employer of the individual by reason of his status as employer. (ii) Other life insurance. - To the extent of the amount receivable (other t'han as insurance includible under (i)) under policies on the life of the individual by his executor or by any other beneficiary with respect to which the individual possessed at his death any incident of ownership, exercisable either alone or in conjunction with any other person. (b) Additional Proceeds Includible. - In any case where (i) within a period of 2 years ending with the date of his death an individual transfers any incident of ownership in a policy of insurance on his life referred to in subsection (a)(ii) and (ii) by reason of such transfer subsection (a) is not applicable, there shall be included in the transfers of the individual at death the amount receiv- able at death as insurance under such policy reduced by the amount previously taxed' under this chapter by reason of such prior transfer. (c) Incident of Ownership. - For purposes of this section, the term "incident of ownership" shall not include any right in or power over a policy of insurance exercisable in a fiduciary capacity unless the insured may derive an economic benefit from the exercise of such right or power. Section 27. Property to Which Section 15 or 32 Applied. There shall b'e included in the transfers of an individual at death all property or a specific portion -33- PAGENO="0117" thereof pssing to beneficiaries (including all amounts accruert or collected with respect to such property or portion but not yet distributed) and not includible in his transfers under any other section of this part as to which (i) a deduction was allowed under section 15 or 32, and (ii) the individual immediately prior to his death possessed a current beneficial interest For purposes of this section the value of the right to receive a fixed dollar amount per year which is payable from a separate fund shall be that percentage of the total as of the termination of such right which the fixed dollar amount is to the annual net income of the fund, as of the date of transfer, computed by use of the rate of return prescribed on such date of transfer for the valuation of interests in transferred property under this chapter. Section 28. Transfer Taxes Paid on Transfers Other Than at Death. There shall be included in the transfers of an individual at death an amount equal to the transfer taxes (1) on his taxable transfers within a period of 2 years ending with the date of his death, and (2) on any other taxable transfers for which a credit is allowable under section 35. Section 29 Disbursements (a) General Rule - There shall be allowed as a deduction amounts allowable under local law which are paid after an individual's death from property included in his transfers at death or included in his transfers within a period of 2 years ending with the date of his death (1) for funeral expenses; (2) for claims against such property, including amounts payable to a spouse under a decree of divorce or of separate maintenance or under the terms of a written instrument incident to such divorce or separation or under a written separation agreement if the spouses lived apart continuously after the entry or execution thereof and (3) for expenses incurred in connection with the administration of such property provided that such expenses incurred in connection with property not subject to claims are paid before the expiration of the period for the assessment of tax under this chapter For purposes of this section a claim founded upon a promise or agreement shall be deductible only to the 103 -34- PAGENO="0118" 104 extent that it (I) Is contracted for an adequate and full consideration in money or money's worth, or (ii) would be deductible under section 31 If the amount were transferred in the form of a bequest. (b) Estate, Succession, Legacy, Inheritance or Transfer Taxes. - No deduction shall be allowed under this section for estate, succession, legacy, inheritance or transfer taxes, except that, if such a tax is imposed on property for which a deduction is allowable under section 31, the executor may, subject to such conditions as are imposed pursuant to regulations prescribed by the Secretary or his delegate, elect to deduct under this section the amount of such tax. Section 30. Losses. [Present §205.14] Section 31. Charitable Deduction. [Present §2055(a)-(e), reworded to conform, except that (I) subsection (c) will begin as follows: "If the tax imposed by section 1, or . . . "; and (ii) a new subsection (e)(3) shall be added: "No deduction shall be allowed under this section for an interest in property for which a deduction is allowed under section 15 or 32 by reason of the same transfer."] Section 32. Marital Deduction. - (a) Allowance of Deduction. - (1) (A) General Rule. - Subject to the limitation of paragraph (2) of this subsection, there shall be allowed as a deduction the value of all property included in an individual's transfers at death which passes outright to his spouse or in which his spouse possesses a current beneficial interest. (B) Property Formerly Held as Community Property. - If after [ , 197 ] property held as community property was by an individual and his spouse converted, by one transaction or a series of transactions, into separate. property of the individual and his spouse (including any form of co-ownership by -35- PAGENO="0119" 105 them), a deduction shall be allowed under this section with respect to any property acquired at any time by him in exchange therefor (by one exchange or a series of exchanges) which shall not exceed one-half the excess of $250 000 over the sum of (i) twice the amounts previously allowed as a deduction under section 15 with respect to transfers of such converted community property, and (ii) all other amounts previously allowed as a deduction under section 15. (2) Limitation. - (A) The deduction provided in paragraph (1) of this subsection, when added to amounts previously deducted under section 15 shall not exceed an amount equal to the greater of $250,000 or one-half of the value of an individual's adjusted transfers. (B) If available records are such that, under regulations prescribed by the Secretary or his delegate, the limitation on the amount of the deduction allowable under this section cannot be computed under subparagraph (A) hereof, (i) the deduction allowed under this section shall not exceed one-half of the value of property transferred at death reduced by the amount of the deductions allowable under sections 29 and 30, and (ii) no deduction shall be permitted under this section for a transfer at death of property described in subparagraph (B) of paragraph (1) of this subsection (C) In computing the applicable limitation imoosed by this paragraph (2), the fact that a deduction is allowed under this subsection for property which is included in the individual s transfers at death under sections 23 or 26(a)(i) shall be disregarded, to the extent that such property constitutes (i) amounts payable or receivable under (1) an employees trust (or unaer a contract purchased by an employees' trust) forming part of a pension stock bonus or profit-sharing plan which at the time of his separation from employment (whether by ceath or otherwise) or at the time of termination of the plan if earlier met the requirements of section 2~01 (a); (2) a retirement annuity contract purchased by an employer (and not by an employees' trust) pursuant to a plan which at the time of his separation from employ- ment (by death or otherwise) or at the time of termination of the plan if earlier was a plan -36- PAGENO="0120" 106 described in section 1t03(a), (3) a retirement annuity contract purchased for an employee by an employer which is an organization referred to in section 170(b)(1)(A)(ii) or (vi) or which is a religious organization (other that a trust), and which is exempt from tax under section 501(a) ~4) chapter 73 of Title 10 of the United States Code; or (5) a plan established in accordance with those provisions of this Title amended by P~L 87-792 to encourage the establishment of volunt~. y pension plans by self-employed individuals; or (ii) proceeds of policies of.group-term life insurance not in excess of $50 000 (3) Effect of Delay in Distribution - The fact that the spouse of an individual will not receive property 0ursuant to an outright transfer, or will not receive the Income from or the use of property or an annuity from property until a distribution of such property is made by an executor or a trustee pursuant to the terms of the governing instrument shall not prevent the spouse's interest in such property from satisfying the requirements for the deduction provided in this section, unless~ the executor or trustee is, by the specific terms of such instrument, authorized or directed to delay the distribution beyond the period reasonably required for administration of the individual's estate. (~) Exercise of Elective Rights. - If the spouse of an individual becomes entitled under local law to exercise a right with respect to property included in the individual's transfer at death, including but not limited to rights of dower or curtesy or a right to an election in lieu thereof and such right is exercised the exercise shall be deemed to have occurred as of the date of death of the individual for purposes of this section. (b) Definitions - For purposes of this section (1) Current Beneficial Interest - (A) the term `current beneficial interest" means a right for life commencing as of the date of transfer (i) to all the income from property or all the income from a specific portion thereof, payable annually or at more frequent intervals, or (ii) to the use of property or a specific portion thereof. (B) For purposes of subparagraph (A), (i) a right to receive payments from a charitable remainder trust (as described in section 6614) shall be considered as a right to all the Income from the prop- erty held in the trust if the payments -37- PAGENO="0121" 107 described in paragraphs (1) (2) or (3)(A) of section 66~4(d) may be made only to the spouse and (ii) a right to receive a fixed amount per year shall be considered a right to receive all the income from property or a specific portion of such property. (2) Property Passing Outright - The term "property which passes outright" includes (1) property (other than property or a specific portion thereof from which payments are to be made pursuant to a right described in paragraph (1)(B)(ii) of this subsection) held as a separate fund under regulations of the Secretary or his delegate in which no person other than the spouse or her estate has any beneficial interest except pursuant to the exercise by the spouse of a general power of appointment described in section 22 and (ii) property paid to the spouse or her estate before the date prescribed for the filing of the transfer tax return as an allowance or award made after the decedent's death pursuant to local law for the support of the spouse during the settlement of the decedent's estate. (3) Adjusted Transfers - The term "adjusted transfers" of an individual means (i) the total value of the individual's transfers during life and subsequent to ,197 ], reduced by any amounts applicable thereto for which exclusions are provided in section 11 and by any amounts for which a deduction was allowed under section 1~4 but not reduced by any amount allowed as a deduction under section 12 ~nd (ii) the total value of the individual's transfers at death reduced by the amount of the deductions allowable under sections 29 and 30. For the purposes of this paragraph a transfer of community property includible in an individual's transfers at death shall be deemed to be a transfer of the entire community interest of both spouses in the property transferred and the transferred amount shall be the aggregate value of both halves of the community property so transferred. (c) Election - An individual may elect by will under regulations prescribed by the Secretary or his -38- PAGENO="0122" 108 delegate, to have all or any portion of his property to which subsection (a.) is applicable treated as property to which said subsection is not applicable. Section 33. Previously Taxed Property. (a) General Rule. - Subject to the limitation of subsection (b.), there shall be allowed as a deduction in computing the taxable transfers of an individual the value of property transferred to the individual within a period of ten years ending with the date of his death to the extent that such property was taxed under this chapter. The value of the property so transferred shall be determined as of the date of the prior transfer. (.b) . Limitation. - (1) The deduction provided in subsection (.a) shall not be available for any interest in a trust or its equivalent except to the extent property constituting the trust or its equivalent is included in the individual's transfers at death or was paid or distributed to him prior to his death. (2) If the date of the prior transfer was more than six years before the individual's death, the deduction provided in subsection (a) shall be reduced as follows: (1) by 20%. if the individual dies after the expiration of six years frcm, but before the expiration of seven years from, the date of the prior transfer; (ii) by LlO% if the individual dies after the expiration of seven years from, but before the expiration of eight years from, the date of the prior transfer; (iii) by 60%. if the individual dies after the expiration of eight years from, but before the expiration of nine years from, the date of the prior transfer; (iv) by 80%. if the individual dies after the end of the ninth year from the date of the prior transfer. Section 3i4~ Credit for Transfers at beath. There shall be allowed as a credit against the tax imposed by section 1 on transfers at death the lesser of (1) the amount of such tax; or (2) $10,000. reduced by an amount equal to a tax imposed at the rate of 10%. on the aggregate of the -39- PAGENO="0123" 109 amounts allowed as a deduction pursuant to section 12 and any equivalent provision of prior law Section 35. Credit for Transfer Taxes Previously Paid. If a tax imposed by section 1 has been paid by an individual with respect to a transfer of property to which section 21 thereafter applies and if after the transfers the property has not been included in the transfers of any other person the amount of such tax shall be allowed as a credit against the tax imposed by section 1 upon such individual's transfers at death. Section 36. Credit for State Death Taxes. [Present §2011] Section 37. Credit for Death Taxes on Remainder. [Present §201.5] Section 38. Credit for Foreign Death Taxes. [Present §201k] Section 39. Liability for Payment. [Present §~2022, 2502(d)] Section LW. Recovery of Taxes Claimed as Credit. [Present §2016] section ki. Definition of Executor. [Present §2203] Section k2. Discharge of Fiduciary from Personal Liability. [Present §220k] Section k3. Reimbursement Out of Estate. [Present §2205] Section kk. Apportionment of Tax. (a) Tax Imposed by Section 1. - Unless an indivi- dual directs otherwise in his will - (1) Property Included Under Section 25 or 27. - if any part of his taxable transfers at death consists of property included in such transfers under section 25 or 27, there shall be paid from such property a portion of the tax imposed by section 1 equal to the tax on the value of such property calculated at the -40- PAGENO="0124" 110 highest marginal rates of tax applicable to his transfers at death. (2) Property Included Under Section 22 or 26. - if any part of his taxable transfers at death consists of property included in such transfers under section 22 or 26, received or receivable by one or more persons other than the executor, there shall be paid from such property such portion of the tax imposed by section 1 (less the tax apportioned under paragraph (1)) as the value of such property bears to the total taxable transfers (less the amount therein to which paragraph (1) is applicable). (3) Property Included Under Section 28. - if any part of his taxable transfers at death consists of an amount included in such transfers under section 28, there shall be paid from the property whose transfer caused section 28 to become applicable such portion of the tax imposed by section 1 (less the tax apportioned under paragzaph (1)) as the value of such amount bears to the total taxable transfers (less the amount therein to which paragraph (1) is applicable). Section L~5. Missionaries in Foreign Service. [Present §2202] Section ~6. Members of the Armed Forces Dying During an Induction Period. [Present §2201] Section 47. Certain Residents of Possessions Considered Citizens of the United States. [Present §~22O8,2501(b)] Section 1t8. Certain Residents of Possessions Considered Nonresidents not Citizens of the United State~. [Present §~209,2501(c)]. -41- PAGENO="0125" 111 COMMENTARY Section 1 Basic Tax This section involves two of the five most important issues in the Draft - what is an appropriate rate structure and whether al transfers made during life or at death should be taxed under a single transfer tax rate structure. A Single Rate Structure Generally speaking, current law imposes an estate tax on transfers at death and a gift tax on transfers during life Each tax has a separate rate schedule and a different exemption. The gift tax rates are three- quarters of the estate tax rates in the same rate brackets. The estate tax exemption (deduction) is $60,000. The gift tax exemption is $30,000. An annual gift tax exclu- sion of $3,000 for gifts of present interests to any number of persons is also available. The gift tax is imposed on the actual amount of the gift - the gift tax itself is not treated as an additional, transfer subjected to tax. Under the estate tax law, the tax itself is subjected to tax because it is imposed on the gross estate reduced only by the deductions. Despite the substantial tax incentive for lifetime giving only a small percentage of the individuals for whom estate tax returns are filed make such gifts in amounts exceeding the lifetime exemption and the annual exclusions An important policy question involved in determin- ing whether there should be a single rate structure applicable to lifetime transfers and transfers at death is the extent to which lifetime giving should be encouraged. We believe such giving should be encouraged and certainly not actively discouraged, because of our belief that it is socially desirable to have property transferred to or for the benefit of younger generations where there is usually a greater need and a greater willingness to make the property productive. Thus, the issue becomes whether the present dual rate structure strikes a proper balance between creating incentives for lifetime giving and being fair as between different taxpayers This question is one upon which reasonable men can differ The fact that the Reporter for the ALl Project decided not to put a resolution involving it before the Institute for a vote indicates the difficulty The Reporter states (pages 56-57): -42- PAGENO="0126" 112 "In the work of the Reporter, the Consultants and the Tax Advisory Group, the underlying question of the desirability or undesirability of shifting from the present dual tax system of estate and gift taxation to a unified tax was extensively considered. The issue was considered by the Council which was almost evenly divided, favoring retention of a dual system by a majority of but one vote. Given the complexity and difficulty of the problem, the time required for its thorough exploration and the im- probability of reaching any clear consensus, the Reporter, with the approval of the Council, did not propose a resolution on the issue. The Institute supported this abstention. There is, therefore, no ALl recommendation on the choice between a dual tax system and a unified tax." We recognize the force of the contention that current law grants an undue preference to lifetime gifts which should be corrected because it prefers the relatively wealthy individual who can afford to make significant life- time gifts over the less well-to-do individual who cannot afford to do so. If it assumed that the revenue to be pro- duced by the transfer tax system is to remain the same under a single rate structure, the "unified' rates would be below the present estate tax rates. The revenue effect of unification - the increase in death taxes that would result from taking into account prior lifetime transfers - has been estimated as a long run increase of 7%. (ALl Project, page 413). Section 1 establishes a single rate structure for all transfers, whether made during life or at death. Our acceptance of a single rate structure is conditioned upon the rates being lowered to offset the additional transfer taxes that will be payable at death by persons who make taxable transfers during life. This qualification accords with~ the position taken by the ALl Project, in recommendation 45, which states (page 57): "Inasmuch as the primary justification for changing to a unified tax system is to keep the rates on deathtime transfers by those who do not or cannot make lifetime transfers at a lower rate than would be possible under a dual tax system, it should be under- stood by those charged with determining the rate structure, if a unified tax is adopted, that the purpose of the shift to a unified tax would be undermined if the rate structure evolved under it were designed to produce more revenue than would be produced under a dual tax system." -43- PAGENO="0127" 113 The Studies not only recommend a single tax structure (page 355), but also propose a "grossing-up concept as to lifetime gifts This concept is e~cplained as follows Cpage 369): "The tax will be imposed upon the fair market value of the property transferred, including in the case of lifetime transfers the amount of the Federal transfer tax incurred on the transfer, which is an integral part of the making of the gift. Under present law the tax upon lifetime gifts is based upon the fair market value of the property transferred exclusive of any gift tax However in the case of testamentary transfers, the present estate tax is imposed on the full value of the property in the es- tate, inciuding that portion used to pay the estate tax imposed Under the unified transfer tax this difference in treatment between lifetime gifts and testamentary transfers is eliminated by grossing up' the fair market value of lifetime gifts, thus causing the transfer tax in effect to be paid out of the property taxed as is the case with testamentary transfers. A table would be provided showing the amount of the grossed-up transfer in order that tax- payers will not be burdened with complex calculations." The Studies then state that "Since some incentive f or making lifetime gifts is economically desirable the present $3 000 annual exclusion would be retained" (page 355). We oppose the use of grossing-up for all lifetime transfers on two grounds First lifetime gifts are actually discouraged since the payment of the additional transfer tax imposed on the tax results in the loss of subsequent earnings on that amount during the remaining life of the transferor. Second, grossing-up is complicated and will not be understood The complexity is indicated by the Studies reference to the necessity of a table in order that taxpayers will not be burdened with complex computations As to understanding a person who makes a transfer of $25 000 to a child recognizes that he has made a gift of that amount but he will have difficulty in comprehending why he will be deemed to have made an additional taxable gift of the tax on the $25 000 The common denominator of the two current but different methods of imposing the estate tax and the gift tax is, of course, simplicity - a desirable but elusive objective. The grossing-up concept is, however, applied in Section 28 as to transfers made within two years of the decedent's death in order to prevent a transfer tax saving by -44- PAGENO="0128" 114 a "death-bed" transfer. The combined effect of Sections 1 and 28 is to reduce substantially the present tax incentive in favor of lifetime gifts and to have as the sole remaining incentive the absence of a tax on the transfer tax itself for transfers made more than two years before death. B. Rate Structure The rate schedule in Section 1 is significantly lower than' the current estate tax rate schedule. Its use would involve a substantial revenue loss and would be warranted only if revenues of approximately, the same amount as the reduction were generated from some other source. Under the Draft, this source is primarily the AET imposed by Section 2. It is, of course, impossible to determine precisely what amount of revenue would be produced by the AET. The Studies state (pages 333-34) "On estate tax returns filed in 1966, the total value of property of a type that might show appreciation (stock, real estate, trust interests and noncorporate business assets) was about $15 billion. The portion of this that represented appreciation was probably in the range of 40 to 50 percent. This suggests that the appreciation passing through the estate of estate tax filers in 1966 must have been in the general magnitude of $6 to $8 billion, or about $7 billion. An additional amount of appreciation about 65 percent as large, or about $4.5 billion, passed from decedents for whom an estate tax return was not required." The figures referred to in the quotation are now out-of-date. More recent figures for estate tax returns filed in 1970* indicate that the total value of assets that might show appreciation is in excess of the $15 billion figure. Further, our experience indicates that the 40-50% figure suggested as the portion represented by appreciation is low. We believe that the additional new revenue that would be derived from subjecting the amount of net appreciation to the AET at a 14% rate of tax, plus that derived from other changes in current law made by the Draft, should closely approximate the annual loss in revenue from the rate schedule set forth in Section 1 after the effect of a single transfer tax rate structure is considered. * Statistics of Income - 1969, Estate Tax Returns, Internal Revenue Service Publication 764 (7-72). -45- PAGENO="0129" 115 The largest percentage reduction in Section 1 rates, as compared to the current estate tax rates, is made in the lower bracket rates. The current estate tax rates commence at 3% on the first $10,000 and then increase rapidly to 30% at a taxable estate of $100,000. This steep progression has been criticized by the ALl Project (pages 47-49), the Studies (pages 355-56, 370) and the overwhelming majority of interested groups and individuals. Section 2. Additional Tax on Certain Transfers A. Introduction Under the current federal estate tax law, property included in a decedent's gross estate is given an income tax basis equal to its estate tax value. Thus, unrealized appreciation in the form of the difference between the decedent's basis and this value escapes income taxation. This result has been criticized as a "loophole" in our present tax laws. Unrealized appreciation at death does not, however, escape tax entirely since it is subject to estate tax. Put another way, imposition of an income tax on such appreciation at death would result in an estate tax loss because the income tax would be a deduction in computing the estate tax. Clearly, no "loophole" exists as to property transferred during life and not subject to federal estate tax because the basis of such property is not increased to its fair market value at the time of the gift. The current basis rule for a decedent's property is also criticized as having an undesirable "lock-in" effect on capital assets which have appreciated substantially since acquisition. An older individual holding such assets acquired many years ago will naturally be reluctant to reduce those assets to cash while alive at a substantial income tax cost when he knows that, if held to death, the assets will receive a stepped-up income tax basis. The "lock-in" problem has been magnified by the changes made in the Tax Reform Act of 1969 which limit the use of the alternative method of computing the tax on capital gains to the first $50,000 of gains and which, subject to certain limitations, impose a minimum tax of 10% on one-half of the gains. The result of these changes is an income tax on capital gains that may exceed the old 25% limitation by more than 10%. We do not believe this problem is susceptible of a truly effective solution without the creation of a significant tax incentive for -46- 68-872 0 . 76 - 9 PAGENO="0130" 116 selling during life. Such a solution night be a transfer tax credit for certain capital gains taxes, which is con- tained in H.R. 3068 that was introduced by Representative Broyhill. Two changes in the current basis rule have been widely discussed. The first is to impose an income tax on unrealized appreciation at the time of transfer, whether during life or at death and, if the transfer is made at death, to allow a deduction in computing the estate tax for this income tax. The second suggested change is to carryover the decedent's basis for his property to the beneficiaries receiving this property as a result of a transfer at death, and to increase the basis of each asset having unrealized appreciation by its proportionate share of the estate tax imposed upon the net unrealized appreciation in all estate assets. Thus, the basis rule for transfers subject to estate tax would, in general, be the same as the present basis rule in section 1015(d) for transfers that are sub- ject to gift tax. The reas9n for increasing the decedent's basis by the part of. the estate tax attributable to the net unrealized appreciation is to prevent a double tax - an estate tax and an income tax - being imposed on an amount equal to `that part. The capital gains tax at death pro- posal eliminates the double tax in a different manner - by granting an estate tax. deduction for the income tax on the net unrealized appreciation at death. Any change in the basis rule will introduce more complexity into the administration of estates and therefore increase the time required to administer them and the costs of administration. Current law has the virtue of simplicity since basis becomes irrelevant upon death and problems of proof of basis disappear. We oppose ~ change in the basis rule unless it is accompanied by a. A reduction in current estate tax rates so that the `cost of dying" is not increased; b. A liberalization in the rules with respect to proof of basis so that if the facts necessary to determine basis are unknown it will be the fair market value as of the date (or approximate date) when the property was acquired by the decedent; and -47- PAGENO="0131" 117 c. A current start-up" date so that property owned by an individual on the effective date of the change would be given a new basis equal to its current market value for the purpose of applying the change to property owned at death Assuming these three conditions would be satisfied we favor taxing unrealized appreciation at death to carryover basis We have however rejected a capital gains tax at death in favor of an additional estate, or transfer, tax (AET) on such appreciation. This tax would apply to property transferred at death and to property transferred within two years of death if it is not sold prior to death. The AET would not apply to other lifetime transfers, as to which carryover basis would be continued. Some people will say that the AET is nothing more than a capital gains tax at death in disguise They are correct in the sense that the result is the same - the taxa- tion of net unrealized appreciation at death. However, as will be explained in detail below there are significant differences between these two approaches to taxing such appreciation These differences are so important to us that if the c'ioice were only between a capital gains tax on net appreciation transferred during life or at death and carryover basis we would favor carryover basis In order fully to understand our reasons for preferring an AET it is necessary to examine in detail the capital gains tax and carryover proposals. B. Carryover Basis The carryover basis concept would raise a number of problems regardless of the exact form the statute would take. Determining Basis Under existing law basis becomes irrelevant upon death. Accordingly, many persons have not maintained satisfactory records with which to establish basis Any change to a carryover basis rule would work to the disadvantage of and produce hardships for individuals who acquired assets from such persons Fairness requires that any carryover basis rule should permit a person acquiring property at death that (i) was owned by the transferor on the date of enactment o~ the rule or (ii) was owned by another person on such date who transferred it by gift to the transferor after that date to use as the transferor s basis the property s value on that date for the purpose of computing gain (but not loss) -48- PAGENO="0132" 118 Administrative Complexity and Suspended Basis If an estate consists of a number of assets the allocation of the increase in basis attributable to the estate tax may require a considerable amount of time. Further, this increase will be uncertain ("suspended") until the estate tax is finally determined and by that time there may have been a number of sales of assets and the income tax returns reporting these sales will have to be readjusted to determine gain or loss to reflect the change in the final estate tax figures Lock-In Carryover perpetuates rather than solves the lock-in problem It is clearly a less satis- factory solution to this problem than current law or a tax on net unrealized appreciation at death, which have the effect of freeing up the flow of capital assets no later than at death Carryover has this effect only to the extent that appreciated property must be sold after death to raise funds with which to pay death taxes, administration expenses and claims. No Satisfactory Way~ to Increase Basis. There is no simple and fair way to provide for an increase in basis for the estate tax attributable to the net unrealized appre- ciation when a marital deduction or community property is involved. Under the carryover proposal, the basis of all estate property (including the qualifying for the marital deduction or the surviving spouse s share of the community property) would be increased by the estate tax attributable to net appreciation.* This result is unfair because property qualifying for the marital deduction, or the surviving spouse's share of the community, does not generate any estate tax The entire basis increase should be allocated to the non-marital property and none to the surviving spouse's share of community property. The effect of not making such an allocation would often be to increase the capital gains taxes incurred to raise funds with which to pay estate taxes be- cause the basis increase in the non-marital property or the decedent spouse s share of community property will be lower than it would be if the entire increase were allocated to such property In a non-community property estate involving the marital deduction a solution is difficult because it will not be known at a decedent s death what property passes to the marital and non-m~rital funds and, therefore, the prop- erty entitled to the basis increase isuncertain at the very * See, for example, Section 106 of H.R. 1040 (The Tax Equity Act of 1973). -49- PAGENO="0133" 119 time sales will be made for taxes. In a community property estate the basis adjustment can easily be allocated entirely to the decedent s half of community assets but in so doing the surviving spouse is penalized because under existing practice sales of community assets to raise funds for taxes adminis- tration expenses and community debts to involve both halves of the community assets and the surviving spouse is involun- tarily burdened with reporting gain realized as to her com- munity half of each community asset sold by the personal representative Mushroom Tax Effect of Carriover In many cases one being where the estate consists of ~i~e asset - a farm or a closely-held business - which cannot be divided for sale to meet its obligations the effect of the carryover basis rule may prove little different from a tax on net appreciation at death In order to raise funds to pay the estate tax, the executor will realize capital gains and will then have to make additional sales to pay the income taxes on the gains, thus creating a "mushroom" tax effect. To the extent that capital gains must be realized in order to raise funds with which to pay the estate tax carryover amounts to a partial capital gains tax at death Fundin9 Marital Bequests There are two basic types of marital deduction formula clauses - pecuniary (fixed sum) amount or fractional share Under current law satisfaction of a pecuniary clause with appreciated prop- erty results in a realization of gain in an amount equal to the difference between the basis and current value of the property when distributed The recipient takes over new bases for the distributed assets equal to their date of distribution values Many lawyers prefer this type of clause to the fractional share clause becauSe it simplifies administration The gain problem could be very serious under carryover basis While it could be cured by changing the income tax law so as not to treat the satisfaction of a marital bequest in a pecuniary amount as a taxable trans- action this solution would not be entirely satisfactory since the executor in funding the bequest could affect the rights of the beneficiaries significantly by his choice of the property that he selects in that he may use high or low basis property The fiduciary duty of impartiality might suggest that the executor would have to make a pro rata division of basis between the marital and non-marital portions of the estate Such a requirement would produce complexity in making partial distributions and tend to remove one of the primary advantages of the pecuniary bequest namely simplicity Net Tax Increase A serious reservation that we -5'O- PAGENO="0134" 120 have regarding carryover is that its enactment would not be accompanied by a significant reduction in transfer tax rates applicable to transfers at death. Under carryover a part of the tax (i.e. the income tax on gain when the property is sold) is deferred until the sale. This, in combination with the addition to basis of the estate tax on net unrealized appreciation, makes it very difficult to devise a reduced rate structure which will properly reflect the additional tax attributable to the carryover. C. Capital Gains Tax on Net Unrealized Appreciation 1. The Proposal A capital gains tax at death was proposed by the Treasury Department in the 1963 hearings before the Ways and Means Committee and was rejected. It was resurrected in slightly modified form in the Studies The major elements of this most recent proposal (the Proposal) are 1. The decedent's final income tax return would include all appreciation on capital assets as if the assets had been sold immediately prior to death. Also, the unrealized appreciation in property transferred by gift rather than at death would be subject to income tax at the time of the transfer. 2. Unrealized losses on capital assets would be allowed on the decedent's final return and if the losses exceed gains an offset would be allowed against capital gains for his three prior taxable years and then against ordinary income for the year of death and three prior years. Losses on lifetime gifts would also be allowed except as to ~ransfers between related parties described in section 267. 3. All gains would be long term regardless of the holding period. 4. The income tax on the gains taxed at death would be deductible in computing the estate tax payable. 5. Only appreciation occurring after enactment would be ta?ced. With regard to assets held on the enactment date in computing gain the taxpayer could claim as his basis the higher of actual basis or value on the enactment date and in computing loss the tax- payer would use the lower of actual basis or value on the enactment date. -51- PAGENO="0135" 121 6. Gain on property qu~~~ifying for the marital or charitable deduction or f~ the orphan S exemption and on personal and household effects having a value of not more than $1 000 per item would not be taxed Losses on all personal and household effects would be disallowed 7 When property passes to a spouse or charity or qualifies for the orphan s exemption and the gain is exempt from tax the basis of all property in the estate would be reallocated to each asset based upon fair market value before the taxable gain, if any, is computed. 8. A minimum basis of $60,000 would be allowed so that no tax would be due if the value of the estate was not more than $60,000. 9. Items giving rise to ordinary income (now classified as income in respect to a decedent) would be accrued and reported on the decedent s `final return but would be eligible for income averaging. 2. ACritiq~ue We believe the Proposal is, for the reasons dis- cussed below, unfair and overly complex and therefore is an unacceptable approach to taxing appreciation at death. a. ~9~essive Nature of Tax. Fairness must be a central feature of any tax. The impact of the Proposal imposed in connection with an estate tax is uneven and favors the large estate. Put another way, the effect of the new tax would be regressive when considered with the estate tax T~is is caused by the removal, through an estate tax deduction for the capital gains tax, from the estate tax base of a portion of the estate assets which would otherwise be taxed at the highest estate tax rate or rates. Thus, the true rate of new tax on the gain is a function of the complement of the highest estate tax rate or rates at which the deducted capital gains tax would otherwise be taxed in the estate (i e the complement of x is lOO-x). To illustrate using current rates an estate taxed at the highest rate of 77% would be subject to an effective net additional tax commencing at only 23% of the actual capital gains tax paid but an estate whose highest estate tax rate was 30% would be subject to an effective net additional tax of at least 70% of the actual capital gains tax paid. Lower estate tax rates alone cannot remedy the inequitable and unfair impact of the capital gains tax proposal on the medium estate. -52- PAGENO="0136" 122 The regressive nature of a capital gains tax on net unrealized appreciation at~ death is clearly demonstrated by the following illustration employing the lower transfer tax rate schedule of the Studies Assume a taxable estate before tax but after expenses and claims have been deducted an~ with no marital or charitable deduction, of $4,500,000, with assets having a total basis of $1,500,000. Under current law, the estate tax is $2,115,400, or 47% of the total estate. Using the maximum 25% rate of tax in effect when the Proposal was made, the capital gains tax is imposed on the appreciation in the estate, $3,000,000, and the amount of this tax, $750,000, is deducted from the assumed estate of $4,500,000 to result in a taxable estate after allowance for the specific exemp- tion of $3,690,000. The transfer tax, using the lower rates proposed in the Studies will then be $1 373 100 The total tax cost of dying will be $2 123 100 a negligible increase of $7,700 in tax revenue over current law. If, however, the taxable estate were $450,000, with assets having a total basis of $150,000, the current estate tax is $110,500, or 24.5%. Again using a 25% rate of tax, the capital gains tax would be $75,000, and the taxable estate before the exemption would be $375,000. The Studies transfer tax is $66,150, and the `cost of dying" will be $141,150 - an increase in tax over current law of $30,650 or 28%. When the percentage increase in tax in the smaller estate is compared with that of the estate ten times larger having the same proportion of net appreciation, the regres- siveness is apparent. Using current capital gains rates, rather than the 25% rate, and the transfer tax rates in the Studies, the disparity in result between the medium and large estate becomes even more pronounced. The increase in tax for the large estate would be 7.6%, while the increase in tax for the medium estate would be 44.7%. The disastrous effect that such an overall increase in tax would have on a medium estate consisting largely of a closely held business is apparent. b Technical Objections to the Prqposal The regressive operation of a capital gains tax on net unrealized appreciation included in a decedent s gross estate is standing alone sufficient reason to justify its rejection, In addition, there are technical reasons to reject the Proposal or parts thereof. -53- PAGENO="0137" 123 ~&$ Complexity The Proposal is needlessly complex Complicated adjustments and computations will be required in all but the simplest estates Exclusions and exemptions are included which are either inappropriate or inadequate Administra- tion is complicated by payment of the tax through t~o returns an income tax return and a transfer tax return The discussion which follows points up the aspects of this unnecessary complexity (a) Reallocation of Basis-Marital Charitable and Orphan s Exclusions The reallocation of basis concept is one of the most objectionable features of the Proposal in that when applicable it would introduce substantial complexity into the administration of estates. The reason for its use is explained as follows: "The exemption on property passing to a sur- viving spouse, to orphans, or to charity requires a special rule relating to basis, so that, in the case of the spouse or orphans the gain that escapes tax at the death of the decedent will be taxed when the property is transferred by such spouse or orphan The basic objective of using allocated rather than actual basis is to eliminate any tax incentive for the decedent or his executor to transfer any particular piece of property to any particular person or entity where such a disposition might be undesirable from a nontax standpoint (Studies at page 345) Reallocation of basis would be unnecessary if there were no exemptions for transfers to certain classes of beneficiaries. The Proposal takes the position that it is inappropriate to impose a capital gains tax on property which qualifies for the marital deduction for the charitable deduction or subject to certain limitations which passes to orphans (a child of the decedent under the age of 21 years if the other parent of the child does not survive the decedent) When applicable the exemptions would create a hybrid system of part capital gains tax at death and part carryover of basis that would raise administrative problems and add considerably to the time required to administer estates The most serious administrative problem - that of unknown basis - will arise in any case where a reallocation -54-' PAGENO="0138" 124 is required and, as is usually the case, the "exempt" property is not segregated as of the decedent's death, To illustrate, assume that the decedent leaves one-half of his residuary estate to his wife and one-half to his children and the executor makes sales of assets shortly after death, in part to raise cash for expenses, claims and taxes and in part for investment reasons. How is the executor to determine the income tax cost basis for the assets sold? Logically, all sales for expenses, claims and taxes or for investment reasons and allocable to the children's share should be exempt from tax except to the extent the value of the property sold exceeds its estate tax value and all sales for investment reasons and allocable to the marital share should be taxed based upon reallocated basis. It is, however, impossible to make such differentiations until the administration of the estate is completed and the amounts needed for expenses, claims and taxes are finally determined and the respective shares are fully distributed. As a practical matter, the reallocation of basis provision is, because of the un- certainty it produces, unworkable in the type of "typical" case under discussion. Reallocation would apply to a large number of estates (apparently even to cases where charity is given a small cash bequest); when there are a number of different assets the reallocation process would he time-consuming. Further, a serious problem would be presented in connection with funding marital bequests. Even assuming that a complete inter-spousal exemption is enacted, there would still be many cases where the decedent would prefer to divide his property in such a manner that one-half would be taxed in his estate and one-half in his wife's estate in order to reduce the combined trarsfer taxes on both estates. Thus marital deduction formula clauses would continue to be used and the same problem discussed above concerning the realization of gain upon the funding of a bequest of a pecuniary amount qualifying for the deduction would be present. The orphan's exemption bears no relationship to need and seems unnecessary. An allowance for minor children was a part of the estate tax law until 1950 (1939 Code, section 812(b) (5)). It was repealed. No reason has been given that justifies its reinsertion into the law, particularly if there is a reduction in the transfer tax imposed on transfers at death. Also, its amount - $3,000 multip~.ied by the difference between 21 and the child's age at the decedent's death - will in many cases be hopelessly inadequate and not even cover basic educational costs. The charitable exemption in the Proposal, seems -55.- PAGENO="0139" 125 unduly broad in that it would appear to exempt from any ta~ gain on assets transferred to charity in satisfaction of a cash legacy where the benefit of the exemption would not increase the amount passing to charity. (b) Interdependent Co~putations The Proposal may involve interdependent computa- tions of the capital gains tax and the transfer tax when gain must be recognized to pay administration expenses and claims and the capital gains tax will reduce the value of property that will pass to the surviving spouse or charity and qualify for the marital or charitable deduction. The amount of the marital or charitable deduction is dependent upon the capital gains tax and the amount of this tax is dependent upon the amount of property that qualifies for the deduction. An unlimited marital deduction does not avoid this problem. The average practitioner will, at best, have difficulty with the interdependent computations and, at Worst, be unable cor- rectly to determine the taxes. (c) Income inResp~ect of a Decedent The Proposal would change the current method of tax- ing income in respect of a decedent, commonly referred to as 691 income. This change is not a necessary part of evolving a system for taxing net appreciation at death, which is funda- mentally concerned with taxing capital rather than income. The Studies state (page 347) with respect to 691 income: `The rules presently contained in section 691 were developed to avoid the bunching of income in the decedent s final return But the complexities of section 691 have created troublesome problems. Therefore, for decedents dying after December 31, 1969, section 691 would cease to have application. The basic rule would be that gain on an asset the sale or exchange of which would produce ordinary income or capital gain, or a combination of both, will be taxed at death with ordinary income to the required extent and capital gain as to the re- mainder~" (emphasis added) Under the Proposal a recipient of property now classified as 691 income and subject to taxation as ordinary income would receive a basis for such property equal to its value on the applicable vali ation date and the amounts received oy the recipient in excess of (or below) basis would result in ordinary income (or loss) In substance the Proposal would recreate the problem - bunching of income at one point -56- PAGENO="0140" 126 of time which will actually be received over a longer period - which led to the enactment of section 691 in the first place The quotation creates afalse impression. The major administrative problems relate not to bunching but to liquidity and valuation 691 income is unique in that in many cases it is not marketable and/or difficult to value. The Studies recognize that liquidity is a problem. It is, therefore, difficult to understand why the Proposal accentu- ates this problem by accruing all payments in the decedent's final taxable period The quotation also creates the impression that the complexities relating to 691 income will be removed if it is accrued at death. This is not the case. The same problems would continue to exist under an accrual concept. When the income in respect of a decedent will fluctuate in amount and is not payable upon the decedent's death (thus requiring a discount in taxing it in the decedent'sfinal return) its receipt by the recipient will result in the realization of ordinary income (or an ordinary loss) under the Proposal. In such cases the Proposal does not simplify but rather complicates the taxation of 691 income since the slateis not wiped clean as of death. Further, in some cases the recipient might not be able to take advantage of any ordinary loss that would be available under the Proposal (d) Net Losses The Proposal would permit any net unrealized loss at death to offset gains in the decedent's final taxable year, then to offset gains realized during the three preceding tax- able years and finally, subject to certain limitations, to offset ordinary income for the year of death and the three preceding taxable years. Aaditional complexity and. expense would result from refund claims while the benefit to be de- rived from refunds is lessened by the higher transfer tax as a result of any refund being an asset of the decedent's estate and increasing the gross estate. Further, when there is a net loss upon death, the benefit to be derived from it may depend upon the time of year during which the decedent died (which will affect his income for that year) and his income, includ- ing gains, during the preceding three years. Taxpayers in identical positions as to the amount of the net loss would. be treated differently The Proposal's handling of losses presents an obvious incOnsistency between lifetime transfers and trans- fers at death The Studies state (page 339) -57- PAGENO="0141" 127 Losses will be allowed on lifetime gifts under the same rules as apply at death How- ever no losses will be allowed on transfers between related parties The provisions regarding disallowance of losses on sales or transfers between related parties are found in section 267. Related parties include a transferor's brothers and sisters, spouse, ancestors and lineal descendants and a trustee of a trust created by the transferor. Thus, because of the broad scope of the term related parties, losses would not be allowed on substantially all transfers of property than an individual would desire to make The provisions of section 267 are not applicable to estates. Estate of Hanna, 37 T.C. 63 (1961), rev'd, 320 F.2d 54 (6th ~`i'r. 1963). Since losses will be allowed on transfers to related parties at death a result of the Proposal is to penalize lifetime giving (e) Start-Up Date The Proposal takes the position with respect to assets acquired prior to the enactment date that in computing gain basis will be the higher of (1) the basis of the asset immediately before death under current law or (2) its fair market value on the enactment date (adjusted under current law for changes occurring after that date) and that in compu- ting loss basis shall be the lower of (1) or (2). Thus a taxpayer s actual basis for an asset - (1) - will still be important even though the asset is not sold during his life. This introduces complexity and in some cases it will be impossible to establish actual basis (f) Minimum Basis and Exclusions from Tax for Types of Propey~ By allowing a minimum basis of $60 000 the Pro- posal exempts from tax a substantial amount of net un- realized appreciation. If the imposition of a capital gains tax on unrealized appreciation at death is sound we ques- tion the advisability of creating such a liberal income tax exemption Based upon the estimates referred to fn the Studies (page 334) approximately 35% of the net unrealized appreciation passing at death is a part of estates not re- quired to file an estate tax return The fact that the Pro- posal s minimum basis coincides with the $60 000 estate tax exemption points up the close relationship between the capi- tal gains tax at death and the estate tax Both are taxes imposed on capital The Proposal exempts from the tax all gain on -58- PAGENO="0142" 128 ordinary personal and household effects of a value of less than $1,000 per item and provides that no loss will be allowed for personal and household effects. The per item exclusion is too low, and should be higher so as to minimize proof problems as to basis for should tangibles. The fail- ure of the Proposal to permit losses to offset gains where the value of $1,000 is exceeded is unfair. (g) Source of Payment of Tax Under the Proposal, the net appreciation would be taxed "in the final income tax return of the decedent." While such an approach is understandable in the case of appreciation on property owned solely by the decedent at his death, it presents a problem regarding property that is not so owned, such as property held in an irrevocable trust or jointly held property. It would be unfair, and perhaps un- constitutional, to impose an income tax on net appreciation attributable to non-probate property against the decedent's probate estate when the beneficiaries of the non-probate property and the probate estate are different - the tax should be imposed on the owner of the non-probate property.* This solution would, however, be troublesome where, for example, the non-probate property has net appreciation but the property in the estate has a net loss in that the loss could not be used to offset the gain. 2. Effect on State Income Taxes The Proposal contemplates that "persons holding appreciated assets at death would be treated as if they had sold such assets just `before death, and such gains would be taxed in the final income tax return of the decedent." A number of states have income tax statutes whose starting point in determining the state tax is taxable income for federal income tax purposes, with certain adjustments that do not include a reduction for capital gains. Thus, unless legislative changes were enacted in these states, which wotild be unlikely, the Pro- posal would result in not only a federal tax but also a state income tax on the gaiq.' This is an undesirable re- sult in that it would raise the "cost of dying" even higher. * If a surviving joint tenant has ownership rights in the property under applicable state law, it is questionable whether an income tax on the net appreciation in his or her share could be imposed as a result of the death of the deceased joint tenant. -59- PAGENO="0143" 129 D. An Additional Estate Tax on Net Appreciation 1. General Explanation The most satisfactory way of taxing net apprecia~ tion at death is by the imposition of an additional estate (transfer) tax The A~T would be applied at a single 14% rate to net appreciation included in (i) an individual 5 transfers at death and (ii) in his transfers made in the two years immediately preceding death unless the transferred property is sold before death Thus the AET could not be avoided by a transfer in contemplation of death' A minimum basis equal to the exemption for transfers at death would be allowed in order that no AET would be owed by any decedent S estate not required to file a transfer tax return Current law - carryover basis - would be continued as to a~.l other lifetime transfers. The credits applicable to the basic transfer tax would not apply to the AET. No exclusion from the AET would be available for property included in transfers at death and qualifying for the marital or charitable deduction. In the interest of simplicity, no special rule is established for depreciable property, including that subject to recapture under section 1245 or 1250. This simplified treatment contrasts with the treatment of such property under current Canadian law imposing a capital gains tax at death pursuant to which this property would be considered to have been sold for an amount midway between fair market value and the original cost less depreciation. Only appreciation occurring after the effective date of the AET would be subject to the tax The start-up date would apply to each spouse ~ share of community property The use of a start-up date will necessitate a gradual five year phase-in of the Section 1 basic transfer tax rates in order to prevent an immediate revenue loss. The choice between a start-up date with gradual basic transfer tax rate reduction and immediate full rate relief with use for AET purposes of actual basis will obviously affect individuals differently - the individual who dies shortly after the effective date of the Draft with little unrealized apprecia- tion in his assets will derive no real benefit from the AET s start-up date while the individual who dies at tne same time with assets containing significant appreciation would probably be disadvantaged by the use of actual basis under the AET regardless of an immediatel~ effective full reduction in the transfer tax rates On balance we believe a start-up date is appropriate mainly because it seems unfair to penalize persons who did not keep an accurate record of -60- PAGENO="0144" 130 basis in reliance upon existing law. No benefit is provided under the AET for a tax rebate attributable to a net loss at death. Since a con- sequence of the AET is a reduction in the basic transfer tax rates, the decedent with a loss will still receive the benefit of a reduced tax imposed under Section 1 and will be better off than under current law. If it is deemed advisable to give relief to an estate with a net loss this could he done (i) by permitting a reduction of the basic transfer tax in an amount that would be the equivalent of what the AET would have been if the estate's basis for its property had been its fair market value on the applicable valuation date reduced by the net loss or (ii) by permitting carryover basis, assuming that the decedent's basis may be substantiated. An AET has three main advantages over the Proposal. They are: Fairness. The effect of the tax is progressive as a result of the entire net appreciation being sub- ject to both the basic transfer tax and the AET. Simplicity. The collection and administration of a tax on net unrealized appreciation at death would be simplified by combining it with the estate tax collection process since there would be *a single collection and audit (involving the same valuations) by a single auditing agent. Constitutionality. Some people believe that the imposition of a capital gains tax on net un- realized appreciation at death would be unconstitu- tional. We disagree with this conclusion. Never- theless, any problem in this regard is avoided by the AET, which is an excise tax as contrasted to an income tax a The Method of Determining the Tax There is an element of double taxation in taxing appreciation at death if the full value of the estate is subject to transfer tax and the full amount of the net appreciation at death is subject to the AET. The Proposal avoids this result by allowing a transfer tax deduction for the capital gains tax. The logical way of avoiding this result in connection with the AET is to increase the basis of the decedent's property by the transfer tax attributable to the net appreciation before imposition of the AET How- ever, providing such a basis step-up in computing the AET introduces regression in the sane manner as exists under -61- PAGENO="0145" 131 the Proposal because the higher marginal rate at which the appreciation is taxed in the large estate results in a proportionately larger step-up in basis in such an estate than in a medium estate in a lower marginal tax bracket. At the cost of logic, regression can be eliminated by making no provision for an adjustment to basis, thus freeing the computation of the AET from the basic transfer tax rates in Section 1. Such an approach does, however, introduce an element of double taxation into the transfer tax structure. This double tax has the effect of making the AET progressive in the sense that given the same amount of net appreciation the AET is more significant in the case of the large estate because the double tax element is proportionately larger in that estate. Under present section 1015(d) the basis of property transferred by gift may be increased by the gift tax paid. The step-up is not limited to the gift tax on the net appreciation but rather is based upon the gift tax on the full value of the transferred property. This result is difficult to justify logically because it is only the net appreciation that is subject to both income tax and gift tax. As mentioned above, the AET would apply to lifetime transfers made within two years of death unless the transferred property were sold before death. Thus, if current section 1015(d) were continued, the double tax element - both a basic transfer tax and an AET on net unrealized appreciation - would not be present in the case of a gift within two years of death as a result of the basis step-up. In order to prevent an income tax incentive for transfers `in contemplation of death", section 1015(d) should be revised to eliminate the step-up basis for such a transfer. This section should also be revised to limit the basis step-up in other cases to the transfer tax on the net appreciation. b. Rate of Tax The double tax element previously referred to justifies a rate substantially below the applicable capital gains tax rate or rates. The AET rate reflects the comple- ment of the highest transfer tax rate and the highest capi- tal gains tax rate.* In this way a decedent whose net unrealized appreciation is subjected to the highest transfer tax rate would pay approximately the same total tax as he *The complement of x is l00-x. -62- 68-872 0 - 76 - 10 PAGENO="0146" 132 would pay if a capital gains tax on this appreciation at death were imposed and a deduction for this tax were allowed in computing the transfer tax. Other decedents except those with small taxable incomes in the year of death would pay a smaller AET than they would pay under a capital gains tax at death. The highest transfer tax rate under the Draft is 60%. Using this rate and a current capital gains tax rate of 35%, the AET would be set at 14% - 35% x 40% (100-60). c. Treatment of Ap~'reciation Qualifying for Marital and Charitable Deductions Section 2 grants no dispensation from the AFT for transfers that qualify fo.r the marital or charitable deduction. As a matter of theory, imposition of a tax on appreciation should not turn upon the destination or use of the appreciation. Further, if exemptions from the AFT based upon the recipients of the property subjected to the tax or adjustments to it are introduced, simplicity is lost, and administration becomes complex. It is time that simplicity and ease of administration, whether it works "for" or "against" the taxpayer, be considered as priority objectives in the enactment of tax laws. (1) The Marital Deduction The marital deduction provides a postponement of estate tax in the estate of the first spouse to die; the deferred tax becomes payable upon the death of the surviving spouse * An AET exemption for property which qualifies for the marital deduction would similarly delay AFT liability in the first spouse's estate. This would, however, be a mixed blessing for the surviving spouse. VYhile more funds might be available for her use during her life- time, she would hold the assets qualifying for the marital deduction with a basis equal to that of the decedent. Thus, the "lock-in' effect would be accentuated and if the spouse sold the appreciated assets the entire appreciation would be taxed under the income tax at rates which might be sub- stantially higher than the AET rate. The failure to grant an exemption from the AFT for marital deduction property obviously produces a hiqher tax upon the death of the first spouse to die than if an exemption were granted. This "additional" tax will be particularly significant in the case of the medium estate, say between $100,000 and $500,000. The impact of the additional tax on such estates will, however, be mitigated by the basic estate tax rate reduction contained in Section 1. Further relief is made available by increasing the maximum marital deduction to the greater of $250,000 or -63- PAGENO="0147" 133 one-half of the adjusted transfers Still further relief is made available by not considering the 14.ET as a debt of the estate for marital deduction purposes under Section 32, with the result that the maximum marital deduction avail- able on the death of the first of two spouses tdP die is not affected by the AET. (2) The Charitable Deduction Under Section 2(a) (1) the AET will apply to any transfer, including one that is entirely or partially charitable, made at death or within two years of the gran- tor's death. On the other hand, the AET will not apply to any transfer made more than two years prior to the gran- tor's death where the transfer is partially charitable and no non-charitable beneficiary has an interest in the prop- erty transferred after the grantor's death. The exclusion- ary rule for transfers made outside of the two year period will apply to those made to pooled income funds or to charitable remainder trusts even though the grantor retains an interest in or a power over the transferred property or to entirely charitable transfers where the grantor retains a right to designate the charitable beneficiaries, This result is accomplished by changing current estate tax law and excluding under Section 21 of the Draft such transfers from the individual's transfers at death, which (except for property transferred within two years of death) constitute the property upon which the AET is imposed. In cases where the AET is imposed, a differen- tiation is made in the amount subject to tax depending upon whether Section 21 is applicable. If that section is not applicable as would be the case with a wholly charitable transfer made within the two year period or with a transfer made within the two year period to a pooled income fund or a charitable remainder trust where as of the date of transfer it is certain that there will he no non-charitable bene- ficiary of the property after the grantor s death, the value of the property transferred, determinedas of the time of transfer will be the figure against which the basis is applied in determining the AET. If as a result of a non-charitable beneficiary having an interest succeeding the grantor s interest in a pooled income fund or charitable remainder trust created during the grantor s life there is a taxable interest in the fund or trust, the value of the transferred property as of the date of death or the alternate valuation date (rather than its value on the date of the creation of the trust) will be subject to the AET as a result of the transfer hc~ang in- cluded in the grantor's transfers at death under Section 21. -64- PAGENO="0148" 134 When Section 21 is applicable, the problem arises as to what the income tax basis of the property should be in computing the AET. A charitable remainder trust is exempt from income tax and a pooled income fund is also exempt from tax on long term (but not short term) capital gains. A loophole" would exist if the basis for computing the AET was the basis of the assets held at death because the tax could be avoided at no cost in capital gains tax by selling appreciated property transferred by the grantor immediately after receipt. This result is avoided by providing in Sec- tion 2(b) (3) that the basis to be used in computing the AET is the donee's basis for the assets originally transferred immediately after the transfer plus, in the case of a traris- fer to a charitable remainder trust an upward basis ad- justment equal to the aggregate capital gains taxed to a recipient through the grantor's death. This adjustment will prevent an AET being imposed on amounts subjected to income tax after the transfer and prior to the grantor's death. It will no doubt be contended by some persons that granting an exemption from the AET for charitable transfers which "take effect" at death is inappropriate. On the other hand, Other persons will contend that an AET should not be imposed on ~ charitable transfer. The position taken in the Draft is a compromise of these conflicting positions. The AET may be avoided for charitable transfers, but only if the transfer is made outside of the normal two year "contem- plation of death" period and the grantor creates an irrevoc- able interest in property to charity during his life. Although Section 2 does not grant an AET exemption for transfers of appreciated property to charity, indirect relief is provided under Section 31 by permitting calculation of the Oharitable deduction for the purpose of the Section 1 transfer tax without reduction for the AET, thus maintaining for the estate the full benefit of the charitable deduction available under current law. For example, if the estate of $4,500,000 previously used for illustrative purposes were bequeathed in its entirety to charity, an AET of $420,000 would be payable on the entire appreciation in the estate, $3,000,000. Although the charity would actually receive no more than $4,080,000, the estate may claim a charitable deduction of $4,500,000 under Section 31. As the apprecia- tion in an estate increases, the benefit to charity for this provision becomes proportionately greater because of the higher marginal rates at which the transfer tax would be imposed on the AET amount. -65- PAGENO="0149" 135 2. Technical Explanation a. Imposition of Tax - Section 2(a)(l). Subsection (a) imposes the AET at a 14% rate on the net appreciation in the transfers of an individual at death or within two years immediately preceding death. The two year provision excepts from its application any property that is disposed of prior to death in a transaction resulting in the recognition in full of gain or loss. This provision prevents avoidance of the AET by a transfer "in contemplation of death". As used in Section 2(a) (1), "the recognition in full of gain or loss" upon a disposition by a recipient of transferred property means that the full gain or loss realized by reason of such disposition is included in the calculation of his income tax liability. Thus, the sale prior to the grantor's death of property transferred by him within two years of his death to a charitable trust described in section 4947 (a) (1) , to a charitable remainder trust de- scribed in section 664 or to a pooled income fund described in section 642(c) (5) will not avoid the application of the AET. Net appreciation is the difference between the fair market value of the property (the "estate tax value" concept of current law) and the basis of such property. The appropri- ate basis for different assets is determined through the ap- plication of subsections (b), (c) and (d). b. Special Election for Community Property - Section 2(a) (21 Current law (section 1014(b) (6) and (7)) provides a change in basis for a surviving spouse's share of community property upon the death of the other spouse to its value on the applicable valuation date for the deceased spouse's share of this property. This result is inappropriate in the con- text of art AET since it would permit the complete avoidance of a tax on one-half of the unrealized appreciation in com- munity property that occurs prior to the death of one of the spouses. A distinction in treatment of separate property and community property for AET purposes is justified by the differences in these two types of property. Two approaches to community property and the AET were considered. First, the surviving spouse's share of community property could be subject to the AET along with the deceased spouse's share. Although permissible (see Fernandez v. Wiener, 326 U.S. 340 (1945)), this approach seems unfair in that the differences between separate and community property would not be recognized. Second, carry- over basis could be applied to the surviving spouse's share, -66- PAGENO="0150" 136 with the result that the basis for this spouse's share would be one-half of the total basis for the community property immediately prior to the other spouse's death. The second approach has been used, except that an election has been given to the surviving spouse to subject her share of the community property to tax at the AET rate of 14%. If an elec- tion were made, current law providing for an increase in basis would be continued for his or her share of the community prop- erty. An election is appropriate because in some cases the death of one of the spouses will virtually compel the sale of community property and it would be unfair not to permit the surviving spouse to take advantage of the AET if it would produce a lower tax on her share of the property sold. The AET which becomes payable by reason of the surviving spouse's. election would be chargeable to her share of the community property. If the surviving spouse makes an election, the AET on her share of the community property that is subject to the tax is computed separately from the AET on the deceased spouse's property. This separate tax computation makes it impossible for the surviving spouse to make an election for the purpose of reducing the deceased spouse's' AET by using a loss on the surviving spouse's share of community property to offset a gain on the deceased spouse's separate property. The surviving spouse's AET is under the specific language of subparagraph (A) to be computed by use of the same valuation method used by the deceased spouse - date of death or the alternate valuation date. The election is available regardless of the type of community property involved. Thus, it could be used by the husband when the wife died first for pre-1927 California community property even though the wife has only an expec- tancy in such property or by a husband in any other community property state where the wife also has only an expectancy. Two limitations on the election are provided one in subparagraph (A) and one in subparagraph (B). The first of these -- a procedural matter --. provides that the election must be made no later than the date for the filing of the deceased spouse's transfer tax return. It is anticipated that the regulations would prescribe the method of making the election. The most satisfactory method would appear to be that used for the election of the alternate valuation date - checking a box on the transfer tax return - and the signature of the spouse on the return. The second limitation, a substantive one, has been imposed as a result of the term "(held as of the date -67- PAGENO="0151" 137 of the deceased spouse s death) in subparagraph (A) which means that the election is not available with respect to community property that is transferred prior to the death of the deceased spouse. Thus, if the deceased spouse's share of community property is subjected to the AET by reason of a transfer within two years prior to death, his spouse is not permitted the election of subsection (a) (2) with respect to her share of any community property trans- ferred before death No hardship can result to the sur- viving spouse in such a case since she does not own the property at death c Basis - Section 2(b) (c) and (d) Subsection (b) provides the general rule to be used in determining the basis of the decedent's assets. It is separately stated for the decedent spouse and the sur- viving spouse's share of community property. The only difference between the treatment of the two spouses is that the surviving spouse is not entitled to use the minimum basis provision contained in subsection (b) (1) The total basis for all transfers covered by subsection (a) deter- mined under subsections (b) (C) and (d) is subtracted from the total value of such transfers on the date of death to arrive at the amount of net appreciation subject to the AET For basis purposes, the assets are divided into subsection (C) assets and all other assets The basis of subsection (c) assets is their fair market value on the application valuation date. The basis of all other assets will be the greater of (i) the aggregate of the assets' individual bases in the hands of the decedent immediately before death or (ii) $100,000 reduced by the aggregate of the amounts previously allowed as a specific exemption under Section 12 with respect to transfers made more than two years prior to death. The minimum basis under (ii) may not, in contrast to the Proposal, be used against ordinary income items. N Subsection (c) exempts from the AET (i) each item of tangible personal property held cy the decedent for personal use and having a value on the valuation date of no more than $5 000 and (ii) all other items of tangible personal property having a value on the valuation date of less than the decedent s basis The effect of these two exemptions will be to remove substantially all tangibles from the operation of the AET This removal is a two-way street in the sense that no gain or loss is involved on -68- PAGENO="0152" 138 exempted items. In applying (i), items normally sold as a unit would be treated as a single item. Examples would be a stamp or coin collection. Consideration was given to imposing a dollar ceiling on the total value of tangibles held for personal use with net appreciation that would be exempted from the AET. Such a limitation was rejected because of the complexity that would be produced in cases where the tangibles were left to several persons and an allocation of the exemption would be required. Further, as a result of items normally sold as a set or collection being treated as one item the significance of a dollar ceiling is substantially reduced. As a practical matter, it would seem that the application of the AET to tangibles would be limited to works of art, jewelry, rare books, stamp and coin collections and rare furniture. Certain other assets which are subject to special rules for income tax purposes, namely, life insurance (section 101), annuities (section 72), and income in respect of a decedent (section 691), are exempted from the AET. This exemption will have no effect on the income tax treatment of the exempted assets. A type of income in respect of a decedent, pension and profit sharing benefits, is specifically mentioned in order to make it clear that such benefits will continue to be subject to both income tax and transfer tax. The inclusion of pension and profit shari~Thenefits as income in respect of a decedent is consistent with the holding of Mess v. Comm'r, 271 F.2d 104 (3rd Cir. 1959). Cash is also ref~erre& to in order that it does not enter into the computation of the minimum base. Subsection (d) provides a start-up date for the computation of the AET and gives a current basis for property acquired prior to the effective date of Section 2. The basis of all such property will be the fair market value of the property on the effective date of the section, as adjusted in the normal course under section 1016 for the period after the effective date up to the decedent's death. Thus, the use of actual basis is eliminated in this area. Those who have such records will suffer under subsection (d) if their capital assets depreciated in value prior to the effective date of Section 2, but the advantages to be gained through simplicity in the statute and through the minimization of problems in the proof of basis area for such previously acquired assets outweigh~ the hardship to those who have a provable basis for assets on the effec- tive date in excess of an asset's fair market value on that date. -69- PAGENO="0153" 139 Section 3 Taxable Transfers Other Than at Death This section is the general provision taxing transfers other than at death It replaces section 2503(a) defining the term taxable gifts and includes the limita- tion of section 2512(b) with respect to transfers made for less than a full and adequate consideration in money or money s worth Sections 2511(a), stating that the gift tax applies toall types of transfers of all types of property, and 2512(a) stating that the amount of a gift of property is the value of the property on the date of the gift, are omitted as unnecessary Section 3 is supplemented by the specific provisions on includibility in Sections 4 through 10 of the Draft Once the amount of transfers has been determined, taxable transfers are computed by reducing the value of such transfers by the amounts of any applicable annual exclusions under `ection 11 and by the amounts deduc- tible under the lifetime specific exemption, for transfers treated as transfers at death and as marital or charitable deductions (Sections 12 through 15 of the Draft) The rate schedule of Section 1(b) is then applied to the resulting figure. The last sentence of Section 3 provides that a promise to make a gift will not constitute a transfer under this section, whether or not the promise is enforceable under the applicable local law The term promise includes a pledge and any other commitment to make a transfer deemed to be gratuitous unfunded or unsupported by adequate con- sideration The transfer occurs when the promise is ful- filled by an actual disposition of the subject property by the transferor This provision is included in Section 3 to avoid problems similar to those posed by Rosenthal v Commissioner 205 F 2d 505 (2d Cir 1952) Commissioner v Estate of Copley, 194 F.2d 364 (7th Cir. l952) and John D. Archbold 42 B T A 453 (1940) Current law remains unclear as to whether a promise to make a future transfer which is supported by consideration and is binding under state law is itself a transfer subject to the gift tax See Treas Reg §25 2511-2 Revenue Ruling 69-347 1969-1 Cum Bull 227 The ruling held that at least where the value of the gift may be determined through recognized actuarial principles the gift was complete for gift tax purposes in the year when the taxpayer became legally obligated to perform under the terms of his agreement The ALl Project (pages 79-80, 93-94, 157-61) pro- posed no changes with respect to the subject matter of Sec- tion 3 The Studies (pages 361 369 382) similarly pro- posed no changes in the subject matter of Section 3 except -70- PAGENO="0154" 140 for its recommendation of "grossing up" for lifetime trans- fers, which is discussed in connection with Section 1. Section 4. Certain Property Settlements Section 4 is based upon section 2516 and exempts from transfer tax certain lifetime transfers between spouses in settlement of marital and property rights and for the support of their minor children. As to transfers between spouses, it is needed because the Draft does not permit an unlimited marital deduction. Section 4 provides that, where a husband and wife enter into a written agreement relative to their marital or property rights, any transfers pursuant to the agreement (1) to either spouse in settlement of those rights, or (2) to provide a reasonable allowance for the support of their children during minority will be deemed transfers made for a full consideration, and thus will not be taxable. In the case of a transfer under (1), Section 4 will be applicable only if the spouses live apart continuously for at least two years after the agreement is executed. The general rule under current law is that a re- linquishment or promised relinquishment of marital rights such as dower, curtesy, or a statutory election in lieu thereof does not constitute to any extent a consideration in money or money's worth. Treas. Regs. S25.2512-8. Thus a transfer in exchange for such a relinquishment or promised relinquishment is subject to the gift tax. If the spouses execute a written agreement, however, and a final decree of divorce is rendered within the two years following the execu- tion, section 2516 provides that interspousal transfers pur- suant to the agreement in settlement of marital rights or for the support of minor children will not be taxable as gifts. Section 4 deletes the requirement of divorce from section 2516, and substitutes the requirement for inter- spousal transfers that the parties live separately for the two years immediately following the execution of the agree- ment. This conforms the lifetime consequences of these transfers with the treatment accorded them under Section 29 at death--in each case, they are not taxed, There is no sound reason for differing treatments of these payments dependent on when they are made. The decision to exclude payments made pursuant to a written separation agreement from taxable transfers also brings their treatment under the transfer tax in line with -71- PAGENO="0155" 141 their income tax consequences - under the income tax law they are treated the same as payments made pursuant to a court decree This liberalization of the current gift tax rule might be subject to some abuse in the form of `fake" separations in order to transfer property free of gift tax between spouses, but the two year requirement has been in- serted to prevent this possibility. Neither the Studies nor the ALl Project had to consider the status of inter vivos payments between spouses by reason of their sepa~6n~~ivorce Under the unlimi- ted marital deduction each proposed, any transfer to the transferor s spouse and any transfer made to the other party in a divorce proceeding as a part of any property settlement, even though the transfer is made after the marriage has been dissolved by a final decree would qualify for the deduction (Studies, page 380; ALl Project, page 143). Section 5. Transfer by a Husband or Wife to Third Party Section 5 is taken fromsection 2513 relating to "gift-splitting" of transfers by one spouse to a third party. Section 2513 represents an attempt to equalize the tax consequences of a gift to a third party by a spouse in a common law state with those of a gift of community prop- erty to a third party Each spouse holds a one-half owner- ship interest in commun~.ty property so that a transfer of such property to a third party is made one-half by each spouse Section 2513 permits the same result as to non- community property through an election by the non-donor spouse. If the present rules of section 2056 and 2514 were changed to permit unlimited interspousal transfers at no tax cost, section 2513 would become unnecessary, since the same result could be obtained by simply making a transfer to the non-donor spouse prior to a joint transfer to the third party Because Section 32 retains a limited (but expanded) marital deduction a provision equivalent to section 2513 is required Sections 6 and 24. Joint Interests A Introduction Sections 6 and 24 concern joint interests defined in subsection (c) of each section as an interest in property possessed by two or more individuals (1) jointly with right of survivorship or (2) by the entirety A tenancy in common is not considered a joint interest Joint interests -72- PAGENO="0156" 142 under which each co-owner may draw down the entire property for his own benefit (e.~., a joint bank account) are included under this definition. For purposes of these sections, it is immaterial that a right of survivorship is regarded as con- tingent under applicable local law prior tothe death of a co-owner. Under current law, the imposition of a gift tax upon the creation of Joint interests turns on whether the transfer is deemed complete and, if it is on whether the right of survivorship is destructible during the lives of the joint owners by the unilateral action of one of them If the jointly held property can be withdrawn in full by any joint owner, the creation of the joint interests is treated as an incomplete transfer not immediately taxable Where this is not the case and the right of survivorship is destructible, so that a joint owner can withdraw the value of his interest by unilaterial action at any time prior to his death, the individual who contributed the consideration is deemed to make a transfer of the amount he furnished in excess of the proportionate value of his interest If however the right of survivorship is destructible only by mutual consent of the joint owners the value of each co~owrier s interest will depend on his age in relation to those of the other co-owners - the younger owner has a greater chance of surviving and thus succeeding to all interests in the property In such cases actuarial tables must be used to determine the value of each co-owner's interest. Section 2515 provides an elective exemption from the gift tax with respect to the creation of a tenancy by the entirety in real property. Upon the death of a joint owner, the full value of the property he holds jointly with another at his death is included in his gross estate under section 2040 except such part thereof as may be shown to have originally belonged to such other person and never to have been received or acquired by the latter from the decedent for less than an adequate and full consideration in money or money's worth." This rule, referred to as the "consideration-contributed" test, has created difficult problems of tracing. It also results in the taxation at death of property which may have been subject to the gift tax, with a gift tax credit being allowed under section 2012. The ALl Project (page 11) has summarized the arguments in favor of substantial simplification in this area: -73- PAGENO="0157" 143 `It is very common for two people, particularly husband and wife, to own property jointly with the right of survivorship. The present transfer tax rules applicable to such jointly owned assets are complex, inconsistent and hard to work with. They require tracing of the source of the consideration that went into the acquisition of the jointly owned property. They treat property as passing by gift and then treat the same interest as passing again to the donee at the donor's death if the donor dies first. They frequently require resort to complica- ted actuarial tables to determine values." Three issues must be considered with respect to joint interests (ALl Project, page 113): (1) to what extent is there a completed transfer upon the creation of joint interests; (2) when there is a completed transfer upon crea- tion of the joint interests, how is each joint owner's interest valued in light of the right of survivorship each possesses; and (3) how is the maturing of the right of sur- vivorship to be treated on the death of a joint owner. The resolution of these issues must result in a pattern of tax which is consistent with a general premise of the Draft that property should be taxed only once to each transferor thereof, whether during his life, at his death, or partly during life and partly at death. Under Sections 6 and 24, the transfer tax will be imposed either partly on the crea- tion of joint interests and partly at the death of the transferor-joint owner, or wholly at the çleath of the transferor-joint owner. In either case, the full value of an individual's contributions to joint interests will be taxed only once by reason of the creation of the joint interests and the maturing of the right of survivorship. The Draft does not include a provision equivalent to section 2515, which permits a tenancy by the entirety in real property to be created with no immediate gift tax, regardless of the contributions of each spouse. Because of the Draft's unlimited marital deduction for as much as $250,000 of interspousal transfers, such a provision would be superfluous in the overwhelming majority of cases to which section 2515 presently is applicable. We believe that a special provision is not warranted for the small number of situations where the filing of a transfer tax return and a possible tax payment would be involved. The provisions of Section 6 will interact with the marital deduction sections where one spouse creates a tenancy by the entirety or any other joint interest and the right of survivorship is not unilaterally destructible. In these cases, the particular interest deemed owned by each spouse will be an undivided one-half interest in the -74- PAGENO="0158" 144 whole property, unless the interest of each is accorded a different characterization under local law. To illustrate, assume that an individual purchases real property with $100,000 of his own funds and has the title conveyed to himself and his spouse, as joint owners. In the creation of the joint interest, the individual is treated as making a transfer of $50,000 to his spouse and this amount may be claimed in full as a marital deduction pursuant to the fixed dollar limitation of Section 15(a) (2). If the allow- able marital deduction is subject to the percentage limita- tion, the deduction will be computed on the basis of a $50,000 transfer to the spouse. Both the ALl Project (pages 11-15, 106-14) and the Studies (pages 363, 375, 379) recommend simplification along the lines of Sections 6 and 24 for transfers deemed complete when made - a tax upon the excess of an individual's contribution over his interest in the property immediately after the creation of the joint interests, and a later tax on the value of the individual's interest itself. This approach eliminates the consideration-contributed test with respect to completed transfers, and prevents the imposition of a second tax at death on property contributed to joint interests which was taxed to the transferor during his life * The advantage of simplification far outweighs the estimated "very small" loss of revenue (ALl Project, page 12) resulting from these changes. B. Section 6 1. Subsection (a) - General Rule Joint interests are of two types for transfer tax purposes -- (1) those where the transferor can regain his entire contribution without the consent of any other person, and (2) those where he cannot do so. The former are deemed imcomplete transfers when made, while the latter are treated as completed to the extent that the transferor's contribution exceeds his interest in the property immediately after the joint interests are created. The creation of a joint interest which falls within the first category, e.g., the opening of a joint bank account, is not expressly covered by subsection (a). Because of the power to withdraw more than a proportional share of the total property, it will be treated as an incomplete transfer when made. Withdrawals by the trans- feror will not give rise to a transfer tax unless they. exceed the amount he contributed. At death, when the right of survivorship matures in the other joint owners, the decedent is deemed to make a transfer under Section 24(b) of -75- PAGENO="0159" 145 a part of the total value of the joint interests determined on the basis of his contribution to the creation of such interests To summarize, current law is continued as to joint interests in the first category, e ~ , Treas Regs §25 2511- l(h)(4); Rev. Rul. 69-148, 1969-1 Cum. Bull. 226, and the necessity to prove contribution remains Since most joint tenancies fall in this category, the significance of the changes made by Sections 6 and 24 should not be overestimated. Notwithstanding the continued problems of recordkeeping and tracing required in maintaining a complete file of contribu- tions and withdrawals, we believe that it is preferable to face these problems in order to preserve the "hard-to-complete" approach of the Draft than to endorse the adoption of a general "easy-to-complete" rule. Transfers in the second category are expressly covered by subsection (a). The subsection provides that the transfers of an individual for the calendar quarter in which joint interests in property are created in himself and one or more other individuals shall include the excess of his con- tribution over the value of his interest immediately after their creation In determining the value of an individual s interest, he is regarded as owning an equal undivided share of the total property subject to such interests. Thus, to the extent of the value of the individual s joint interest in the property no transfer tax will be payable upon the creation of joint interests in property For example, if A, B and C acquire property to be held jointly for a total consideration of $300 with A and B each contributing $125, A and B will each include $25 in his transfers as the excess of his contribution ($125) over the value of his interest in the property ($100) immediately after the creation of the joint interests. The rule of the preceding paragraph applies whether or not the right is destructible by unilateral action while A B and C are alive and unless applicable local law directs a different allocation Reference to applicable local law is based upon a recommendation of the ALl Project (page 106) The Studies (page 363) propose that this determination be based upon either local law or a direction of the transferor(s), and if neither is present, each holder of a joint interest would be deemed to possess an equal undivided share in the property The elimination of the need to refer to actuarial tables in valuing a joint owner s interest where the right of survivorship is indestructible will not give rise to. any serious possibilities of abuse or tax avoidance and will simplify greatly the treatment of the creation of such interests. -76- PAGENO="0160" 146 The general provisions of the Draft would apply to an inter vivos termination of joint interests covered by subsectioirT~. Thus if A, in the above example, were to make a transfer of his joint interest to D when the property subject to the joint interests was valued at $450, $150 (one-third of $450) will be included in his transfers. In such a case, the effect of the transfer on the right of survivorship is not material to the treatment of the trans- fer. 2. Subsection (b) - Additions This subsection provides that a contribution made after the creation of the joint interests in property will be treated as a separate creation of such interests to the extent of the contribution. Thus if, in the above example, A were to contribute an additional $150 at a later date he would be deemed to make a transfer to B and C of $100, the excess of his contribution ($150) over his interest in that amount immediately thereafter ($150 divided by 3). C. Section 24 1. Subsection (a) - General Rule This subsection is concerned with joint interests created in a transfer deemed complete when made. An individual's transfers at death include the value of his joint interest, immediately prior to his death, in any prop- erty. As under Section 6(a), each holder of a joint interest to which this subsection is applicable is regarded as owning an equal undivided share in the property, unless a different allocation is provided under applicable local law. It is immaterial that the right of survivorship may have been indestructible during the joint lives of the co-owners. To continue the example set out in the discussion of Section 6, upon the death of A, survived by B and C, at a time when the property held jointly had a value of $450, A will be deemed to make a transfer of $150, one-third of the total value of the property, to B and C, who take by reason of their sur- viving A. The result of subsection (a) is the elimination of the "consideration-contributed" test. The ALl Project (pages 112-13) justifies this elimination as follows: "This result is clearly justified in the true joint tenancy situation, where either joint tenant can draw down his one-half at any time but cannot draw down any more. In such situation, each one in reality receives full control over one-half of -77- PAGENO="0161" 147 the property ~at the time the joint tenancy is crea- ted, and he passes that one-half to the other if he does not elect to destroy the right of survivorship and he dies first. How the consideration was furnished should be an irrelevant inquiry, because such joint tenancy is not a significant means of avoiding any tax under a unified tax. "The abandonment of the consideration-furnished test, where neither concurrent owner can draw down free of the right of survivorship any of the con- currently owned property (the tenancy by the entirety is the principal example), also does not open the door to significant tax avoidance under a unified tax. We concur in this reasoning and believe that the approach of subsection (a) has the additional substantial advantage of simplicity. As indicated previously, both the Studies and the ALl Project recommend this approach for the type of joint interests to which the subsection is applicable. 2. Subsection (b) - Exception Where the creation of joint interests has been treated as an incomplete lifetime transfer, a different approach is required. No tax was imposed on the creation of those interests, and for the entire period they were in existence, the transferor-joint owner had the power to with- draw more than his proportionate share of the property held jointly. Subsection (b) requires that there be included in the transfers at death of a holder of such a joint interest that part of the total value of the property which bears the sane proportion to such total value as his contributions bore to the total consideration furnished for the joint interests. Thus, the subsection continues current law in this regard. This position is the same as that recommended by the ALl Project (pages 109-11), and the Studies (page 375). 3. Subsection (c) - Definition This subsection provides a cross-reference to Section 6(c) for the definition of a joint interest. Since both Sections 6 and 24 relate to the treatment of identical interests, repetition of the definition in Section 24 is unnecessary and the cross-reference will have the added bene- fit of insuring that definitional rules developed with re- spect to one section will be equally applicable to cases arising under the other. -78- 68-872 0 - 76 - 11 PAGENO="0162" 148 Sections 7 and 22. Powers For the most part, Sections 7 and 22, relating to powers of appointment, continue sections 2514 and 2041. These sections apply exclusively to powers held by indi- viduals other than a transferor of the property subject thereto - Sections 9 and 21 apply to powers retained by a transferor. The most significant change made by Sections 7 and 22 relates to a power to consume, invade or appropriate property for the benefit of the holder of the power (the donee) which is limited by an ascertainable standard relat- ing to his health, education, maintenance or support. Under current law, such a power is not a general power of appoint- ment, and its exercise, release, lapse or termination is thus not taxable to him. Under Sections 7 and 22, such a power will be a general power. This change is consistent with the treatment of property subject to such a power under other sections of the Draft, which include for example Sec- ~ions 8 and 25 (a person is considered as a beneficiary if the trustee has such a power to distribute trust property to him), and Section 21 (such a power retained by the trans- feror makes the transfer incomplete when made). Section 22(a) (2) continues the rule of section 2041 (a) (2) that the exercise or release of a general power during the donee's lifetime will result in inclusion of the property in his transfers at death when the property would be included under sections 2035 through 2038 if the donee were the transferor. Since the Draft does not contain a general contemplation of death provision equivalent to sec- tion 2035 and the substance of sections 2036, 2037 and 2038 has been replaced with Section 21, the relevant part of Sec- tion 22(a) (2) is phrased in terms of an exercise or release to which Section 21 would apply at death if the donee had been the transferor. This provision precludes a donee who is also an income beneficiary from releasing his power dur- ing his life, and being taxed only on the then value of the trust property reduced by the value of the income interest. Since Section 7 does not exclude from lifetime transfers an amount which nay thus be includiblé in transfers at death as well, Section 22(c) (1) provides that the value taxed at death must be reduced by the amount previously taxed under Section 7. While this approach does not negate in full the effect of double taxation in these situations, it is prefer- able to retain the familiar provisions on powers to the ex- tent feasible, rather than to attempt a correlation of Sec- tions 7 and 22 with the provisions of Sections 9, 13, 21, 28 and 35 directed at interests in transferred property re- tained by the transferors. Since Section 22 may be applic- able with respect to an inter vivos exercise, release or -79- PAGENO="0163" 149 lapse of a power, subsection (b) (2) refers to Sech~on 7(e) for determining the consequences at death of such a lapse A lapse of a general power is under sections 2514(e) and 2041(b) (2), deemed a release of the power; an exception is provided for a noncumulative annual power of withdrawal in a limited amount (a 5 and 5 power) Section 7 modifies the second sentence of section 2514(e) to provide that the exception applies only where the property subject to the power is not in excess of the $5,000 or 5% amount i e if more than the allowable amount could have been with- arawn no amount is excluded from the general rule of includibility This is appropriate because the e clusiom is intended to allow a transferor to include in the instru- ment a provision making available a minimum amount annually without adverse tax consequences arising from a failure to draw down that amount - it is not intended to insulate a minimum amount of a larger amount which could have been with- drawn. The change has the effect of overruling Fish v. United States, 291 F. Supp. 59 (D.C. Ore. 1968) ~ 432 F.2d (9t~ Cir. 1970). - The Draft includes a provision, Section 16, dealing with disclaimers Accordingly the sentences in sections 2041 (a) (2) and 2514(b) providing that a disclaimer of a general power is not deemed a release of the power are omitted from Sections 7 and 22 as unnecessary No other changes in the current law on powers are made The Studies (pages 362-63 373) propose that current law be continued The ALl Project (pages 18-19, 97-104, 163-65) also recommends that there should be no major change in this area, and has summarized its position on powers of appointment as follows (pages 18-19): Powers of appointment in a transfer that create a succession of limited beneficial interests give a flexibility to the arrangement that permits adjust- ments to meet changed conditions. A rigid and in- flexible plan of successive limited interests is likely to be inadequate to meet the conditions of the future under which it will operate The present transfer tax law is quite liberal in the controls the owner of a limited interest can be given without causing him to be treated as the owner of the aopoin- tive assets for transfer tax purposes This liberality contributes to the generation- skipping problem later considered (see page 26) But a tightening of the power-of-appointment rules to cause the powerholder to be treated as the owner of -80- PAGENO="0164" 150 the appointive assets in more situations than at present would simply tend to drive property arrange- ments into the more rigid mold if the more rigid mold avoided the burdens of transfer taxation Therefore the generation-skipping problem should not be resolved by drawing a different line than now exists in the power-of-appointment area Rather, a solution should be adopted that appli~es equally to the rigid and nonrigid arrangements." We agree with this statement and believe the present "liberal" rule that a broad power of appointment is not taxable is socially useful and desirable. The impact of this flexibility on the "generation-skipping" problem is dealt with in Sections 8 and 25. As previously mentioned, the lapse of a non-cumula- tive annual power of withdrawal over an amount not to exceed the greater of $5,000 or 5% of the trust property is not considered a release of a general power of appointment. How- ever, under section 678 a donee of such a power will be taxed on a portion of the trust income and gains. See Tr~aS. Regs. §Sl.671-3(a) (3) and 1.671-3(b) (3) Rev. Rul. 67-241, 1967-2 Cum Bull 225 A closer correlation between the transfer tax and the income tax provisions is desirable. Section 678 should be amended to change current law so that the donee will not be treated as the owner of any part of the trust's principal solely because of the existence of the power if he is there- after entitled to receive all income in the accounting sense of the trust during the balance of his life or until the earlier termination of the trust The change could be accomplished by changing the caption of section 678(b) and adding to it or with respect to any power over corpus if the property, which could have been vested in the holder of such power by the exercise thereof did not exceed in value the greater of the following amounts (A) $5,000 or (B) 5 percent of the aggregate value of the assets out of which the exercise of the power could have been satisfied and the income from such corous is required to be distributed currently to the holder of such power until his death or the earlier termination of the trust -81- PAGENO="0165" 151 Our suggestion is the same as a part of a recommen- dation made by the Tax Section of the American Bar Association in its 1965 Annual Report except in one respect. The recommen- dation would change section 678 as to the lapse of all 5 and 5 powers whereas our proposal would limit the change to cases where the holder of the power is the sole income beneficiary of the trust. We believe this liberalization should not be available in cases where there may be opportunities for minimizing income taxes on the donee from the exercise of a 5 and 5 power by having accounting income paid to other members of the holder's family or accumulated and taxed to the trust. Sections 8 and 25. Interest in a Trust or its Equivalent A. Introduction The current federal estate and gift tax laws permit property to be held in trust for the maximum period authorized by state law with the imposition of only one transfer tax upon the creation of the trust. During this period beneficial interests in the property may pass through several generations. Thus, through the use of trusts of long duration, several generations nay presently share in the beneficial enjoyment of property without the payment of additional transfer taxes. Some people believe that present law is structurally unsound because it creates a tax preference (or tax incentive) for the use of trusts. The issue involved has become commonly known as the "generation-skipping" problem. B. Proposed Solutions Solutions have been suggested, but to date none has received anything approaching broad support. It is useful to consider these solutions as a prelude to discussing the approach taken in the Draft to this problem. This approach is contained in Sections 8 and 25 which for convenience will hereafter be referred to as "the Statute". The most extreme and complex solution that has been proposed is the one suggested in the Studies. It has been put in statutory form in section 505 of S.3378 intro- duced in the Senate by Senator Gaylord A. Nelson during 1972. The complexity of the Studies proposal has been criticized even by advocates of significant change in this area. See, e.g., Westfall, Revitalizing the Federal Estate and Gift Taxes, ~Tiiarv. L. Rev. 986, at 1006-1013 (1970) . This solution is, as pointed out below, not consistent with its underlying premise, which is that property should be subject to a transfer tax in each generation. In order to accomplish -82- PAGENO="0166" 152 this objective, a substitute (or additional) tax would be imposed upon an outright transfer, or a transfer in trust, of property to a person who is more than one degree below the transferor. The rate of tax would be 60% of the marginal transfer tax rate applicable to the transfers during the taxable period if made during life or to the transfers at death if made at death. Alternatively, the family would have the right to treat the transfer as if the property was first transferred to the skipped genera- tion and, if this were done, the substitute tax would be the amount owed by the skipped generation. The application of the proposal to transfers in trust is summarized as follows: `When the generation-skipping gift or bequest is by trust, there would be generally the aame options as to when the tax must be paid as would be available to the skipped generation had he elected to pay the tax. Thus, the transferor or his representative (i.e., executor or trustee) may elect to treat the taxable event as occurring at the time of the original transfer or as of the first day of any calendar quarter thereafter. In no event, however, may the tax be postponed beyond the date of the death of the last survivor among the group consisting of the transferor, his children, and any beneficiaries under the trust who are not within the category of individuals to whom a gift would be considered a generation- skipping gift. At this time, it becomes certain. that there is a generation-skipping transfer involved and no reason to further defer the tax. "The substitute tax would be computed on the value of the trust corpus as of the effective date of the election or the date of the taxable event. Thus, if an individual put $10,000 in trust, with the income payable to his son and the remainder to his grandchildren, and elected to pay the tax at the time he established the trust, he would he subject to a substitute tax on a transfer of $10,000. If, however, no election to pay the tax was made prior to the death of the transferor and his son, then at that time, a tax would be due computed upon the value of the trust corpus at that time. Since the transferor would be deceased at this time1, the substitute tax in this case would be paid by the\ trustee out of the trust property. Any trust distributions prior to this time which skip a generation would also be subject to the substitute tax as applied to the amount of the -83- PAGENO="0167" 153 distribution. "Once the stthstitute tax has been paid on the value of trust property, the substitute tax would be further applied as if the intervening generation was the transferor. Thus distributions to persons two degrees below the original transferor would not involve an additLonal substitute tax but distri- butions to persons three or more degrees below Ce g , great grandchildren) would be subject to a second substitute tax (Studies, page 392) The proposal in the Studies fails to apply the every generation theory of taxation to all transfers If the tax is to be imposed upon such a theory transfers that do not move "downstream" (to a generation one or more levels below the transferor) but rather "upstream", usually to parents, or "sideways", usually to brothers and sisters, should be exempt from the tax. Yet the Studies' proposal does not contain such an exemption. In fact, it moves in the opposite direction by proposing the elimination of the previously taxed property credit allowed by section 2013, which has its primary significance in connection with transfers between brothers and sisters. ~e believe the proposal is not appropriate as to either outright transfers or transfers in trust With respect to outright transfers we do not under- stand why a substitute tax is appropriate in connection with a gift to a grandchild. Why should such a gift be penalized? There has been no splitting of benefits between generations as there is in a trust transfer If there is an abuse in the generation-skipping area, in our opinion it exists only where such a splitting is present. Further, we know of no country or state that has imposed an additional transfer tax on outright generation-skipping transfers. While the fact that an idea has not been tried before does not automatically justify its rejection, it does suggest that an additional or substitute tax on such transfers is alien to the basic concept of fairness in transfer taxation We agree with the resolution adopted by the ALl Project that Under either a dual tax system or a unified tax, an additional tax should not be imposed on an outright transfer or its equivalent (page 7) We also disagree with the approach of the Studies proposal to transfers in trust The proposal imposes a tax at the wrong time on the wrong' person and is objectionable in this regard for three specific reasons. -84- PAGENO="0168" 154 First, the additional tax is computed by multiplying the value of the taxable transfer by a per- centage of the decedent's marginal tax rate applicable to his transfers at death or, in the case of a lifetime transfer, by a percentage of his marginal rate applicable to all transfers during the taxable period. This tax is incon- sistent with the theory of the generation-skipping proposal because it is computed with reference to the rates applicable to the transferor. The tax should be computed with reference to the rates applicable to the estate of the deceased trust beneficiary, as is usually the case under the Statute. Second, the amount of the additional tax is depend- ent upon the rate applicable to the transfer. Thus, if the first inter vivos transfer is subject to the additional tax, the amount thereof would be lower than it would be if the same transfer is made at death or later during life after other gifts had been made. It is inappropriate to create an incentive for making transfers subject to the additional tax at any particular time to the extent this result may be avoided. The Statute avoids this problem by, in general, computing the tax with reference to the estate of a deceased trust beneficiary. Third, the election device is ill-advised and injects aspects of a lottery into the computation of tax because it permits the amount of the tax to be determined based upon the value at the time of transfer, or based upon the value at a subsequent time no later than the death of the last beneficiary who is no more than one generation below the transferor. This election, which is different from other elections now available to fiduciaries where it is possible to tell precisely at the time of the election what the tax effect of the election will be places an undesired responsibility on the fiduciary with respect to the time of its exercise. No election is permitted under the Statute. We have other objections to the Studies proposal The substitute tax would be applied to a distribution of current income as well as to a distribution of principal (including accumulated income). Such an approach produces complexity and is uncertain in its application. To illustrate, assume that a trust were to last until the death of the survivor of the transferor's children, when the property is to be distributed to his then living issue, ~ ~ and that during the trust term the trustee is to distribute income currently to the trans- feror's issue living from time to time, ~ sti~pes. Every payment of income to a grandchild after his or her ancestor's death and prior to the death of the last survivi'~ child would be subject to an additic~nal tax -85- PAGENO="0169" 155 and transfer tax returns would have to be filed each quarter What is the source of funds to be used for payment of the substitute tax' Is it the income actually payable to the grandchild or is it the trust principal' If it is income, the substitute tax and the income tax on the gross income payable to the grandchild may exceed this income If it is principal the shares of other beneficiaries are adversely and unfairly reduced The Statute avoids these problems by not being applicable to distributions of current income. Our estate tax law has always recognized a distinc- tion between the limited interest of a trust beneficiary and the person who has outright ownership of property. If the income beneficiary of a trust is treated for estate tax purposes as if he owned the trust property outright, a determi- nation is being made that the ownership rights are equivalent. They are not the same and shoul4 not be treated for transfer tax purposes as being the same, as they are under the Studies' proposal, merely because interests in a trust are given to successive generations below the transferor. Professor David Westfall has proposed a much simpler way of handling generation-skipping transfers in trust Westf all Revitalizing the Federal Estate and Gift ~ Taxes 83 Harv L Rev 986 at 1006-1013 (1970) It is to grant a parental deduction of forty percent for pro- perty transferred outright to a child or in such form that the property will be included in the child's estate at his death. The rationale behind this approach is that the incentive of the immediate tax deduction will be sufficient to prevent the use of generation-skipping transfers in trust. We believe there is considerable merit in this approach because it avoids the complexity inherent in any other approach, including that present in the Statute. Unfortunately, Professor Westfall does not have sufficient confidence in his solution to ignore the multiple generation-skipping trust. For such trusts, his February 27, 1973 statement on estate and gift tax reform to the House Committee on Ways and Means says that the Statute is preferable to the proposal of the Studies if coupled with an uncomplicated solution such as in his view the parental deduction for a single generation-skipping trust * The multiple generation-skipping trust should be ignored if Professor Westfall's approach should be followed Subject to this qualification and to the qualification that the deduction would be available for * Professor Westfall s comments were based on a preliminary version of the Statute dated February, 1971. He raised four technical points which in his view required correction. Each of these points is met in the Statute -86- PAGENO="0170" 156 trust property even though. income payments to a grandchild were permitted during a child's life so long as the trust principal would be included in the child's estate at death, we have no real difficulty with this approach, which creates a tax preference for a non-trust disposition. We do, however, have reservations about the acceptance of the Westfall approach because Congress has not been willing as a matter of policy to attack problems in the trusts and estates areas indirectly through tax incentives. Also, while this approach is simple in the sense that a com- plicated statute would not be required, it would produce complexity of its own in the form of an inter-dependent computation. In any case where the tax is payable from property passing to or for the benefit of the child, the tax would apparently depend upon the amount so passing while the amount so passing is dependent upon the amount of the tax. On balance, we believe the Statute is a more viable solution to the generation-skipping problem. The third recent proposal is contained in the following resolutions adopted by the ALl Project: "Under either a dual tax system or a unified tax, the additional tax should be applicable to the transfer of a limited interest if, but only if, distribution of benefits may be made under the transfer to a person more than one generation below the transferor at a time subsequent to the death of a person one generation below the trans- feror. ` * "Such additional tax should be: (a) imposed at the average rate applicable to all transfers by the transferor in the taxable period of the transfer, (b) imposed at the time of the trans- fer or at the time of distribution to a person more than one generation below the transferor, as the transferor or his personal representative may elect, and (C) collectible only out of the property on which the additional tax is imposed, unless the transferor specifies other funds out of which the additional tax is to be paid." (page 31) The Institute approach as to the time of payment and the determination of the additional tax is similar to * The Institute considered this resolution on the understanding that it meant that no additional tax would be imposed on a transfer under which final distribution is required to be made no later than the death of a person or persons one generation below the transferor, or in the same generation or in a higher generation than the transferor. -87- PAGENO="0171" 157 the Studies' proposal concerning these matters and is objectionable for the reasons stated above. Also, in im- posing a single additional tax that is not related to the term of the trust or the number of generations skipped, the Institute approach encourages trusts for the full term of the rule against perpetuities permitted by local law. The Statute is neutral with respect to long-term trusts. The Institute approach regarding the types of trust transfers that are sub- ject to the additional tax did, however, serve as the point of departure to the development of the position taken in the Statute. In discussing possible solutions to the generation- skipping problem, the British experience should be noted. Al- though legislation hasbeenenacted, ithasbeen and remains largely ineffective See Hawkins A Discretionary Object s Interest, British Tax Review 351-376 (Nov. - Dec. l96~); The New Law Journal July 24, 1969 at 691, July 31, 1969 at 714, November 6, 1969 at 1014. Finally, mention should be made of one other approach that has been discussed but which has not been developed in commentary. It is to impose an additional tax at a graduated rate that would be based upon the length of time the trust continues in existence One school of thought is that tax would be payable only when principal is distributed and another says the tax should be paid at certain intervals even though principal has not been distributed This approach presents obvious difficulties not the least of which is determining an appropriate rate structure After considering it at some length, we believe that it is an unrealistic approach to the generation-skipping problem. The Statute does, however contain an element of this approach in subsection (d) C. Rationale of Statute In any estate plan a choice must be made between an outright transfer and a transfer in trust The normal expectation of an heir is to receive property outright Why then should an estate owner make a transfer in trust? It is not to create successive interests in property because they can be created through legal life estates in combina- tion with remainders or through life insurance and annuities or other contractual relationships A trust is used because it provides flexibility and enables the disposition of property to be altered to accommodate changes in circumstance An estate plan may be created which will accomplish the estate owner's objectives for his family through the creation of various -88- PAGENO="0172" powers in the trustee and/or beneficiary, such as investment powers, powers of' appointment and powers to pay income and/or principal to a beneficiery or among the members of a class of beneficiaries. A trust is no more than a single fund in which beneficiaries have an interest which relates to their requirements. The concept of "family" is important in a dis- cussion of generation-skipping In general family means persons living at his death If an individual lives out his actuarial life expectancy, "family" consists of spouse, children and grandchildren. In the case of outright transfers an individual ought to be able to leave property to any member of his family at the price of a single transfer tax. In the case of transfers in trust, if an individual dies prior to the expiration of his actuarial life expectancy he ought not to be penalized by a narrower definition of family, and, similarly, if he outlives his actuarial life expectancy, he ought not to benefit from a broader definition of "family". We believe that any change in the taxation of trust transfers should be accomplished in such a manner that a person may create a trust having his family - his ancestors spouse children and grandchildren - as its beneficiaries without the imposition of an additional trans- fer tax when compared with current law Stated simply the additional tax should be limited to the long term trust where the property does not "vest" for transfer tax purposes - by an outright distribution or a disposition in further trust but subject to a general power of appointment - in a child or grandchild at a time no later than the death of the last living child of the transferor. The tax should be paid from the trust property and should be determined by inclusion of the trust property in the transfers of the skipped beneficiary - usually a child of the transferor The effect of the Statute in the context of a trust for descendants of the transferor, would be to shorten the period during which trust property may be kept outside of the transfer tax base from as much as 100 years to a period not to exceed the life or lives of children of the transferor. The Statute would not inhibit in any way the use of a flexible trust through the creation of various powers in the trustee and/or beneficiary, such as powers of appointment and discretionary powers to pay income or principal among a class of beneficiaries. 158 -89- PAGENO="0173" 159 D General Expla~atiOn of Statute The Statute taxes certain transfers in trust (or their equivalents) upon the termination of beneficial interests therein and in doing so limits the period of time during which property can be held in trust without being subject to transfer tax upon the termination of a bene- ficiary s interest when his descendants are beneficiaries or possible beneficiaries after such termination Generally speaking the method employed to tax trusts that do not vest for transfer tax purposes within the permitted period is to impute ownership of the property to certain persons holding beneficial interests in the property on specific occasions and to tax the transfer of the prop- perty from such a person to his descendants unless the transfer fits within one of the "excluded transfer" pro- visions. This succession tax approach has been used elsewhere and is suggested in Jantscher Trusts and Estate Taxation at 172-190 (1967) The Statute also subjects ~transfer tax the distribution of trust property in situations that do not involve the splitting of trust benefits between successive generations but do involve the passing of trust property more than two generations below the grantor of the trust Excluded transfers have been defined in a manner that enables a person to create a trust which is flexible enough to meet the changing requirements of his family but which protects the federal revenue against multiple generation skips where each generation is given beneficial interests in the ust The effect of the Statute on trust dispositions may obviously be expanded or contracted by expanding or contracting the types of excluded transfers Hereafter the terms excluded transfer and included transfer will be used as short- hand expressions for transfers which either are not or are taxable under the Statute. The starting point in determining the period of time during which property held in trust will not he subject to transfer tax is a resolution of the ALl Project quoted above, but the Statute is broader in scope than this resolution To illustrate under the Institute approach the ultimate recipient of the trust property is irrelevant So long as the distribution iS made no later than the death of a person no more than one generation below the transferor no additional tax is payable even though there may be a skip of several generations say to great-grandchildren upon the death of a child Under the Statute the relationship of the recipient to the transferor is relevant and a tax would be imposed if the recipient -90- PAGENO="0174" 160 is more than two generations below the transferor. Also, under the Institute approach, a person one generation below the transferor may be used as a measuring life `for the duration of the trust without running afoul of the additional tax even though such person is not a beneficiary of the trust. Generally speaking, this is not possible under the `Statute, If a trust is to continue after the death of a beneficiary and property may subsequently pass to such beneficiary's descendants, a tax will be imposed on the death of the beneficiary unless the measuring life or lives are persons no more than one generation below and also are beneficiaries of the trust, viz., they are entitled absolutely or in the discretion GUthe trustee to receive income or principal from the trust. The imposition of a transfer tax under the Statute on a distribution of trust principal to a descendant of the transferor other than a child of the transferor is avoided only when the trust property passes to a grandchild of the transferor in a manner that it will be subject to transfer tax as a part of the grandchild's estate. Thus, a one generation skip at the nearest generation level without a transfer tax is not always permitted. Rather, it is permitted only as between children and grandchildren (or similarly related collaterals). To illustrate this point, assume a transfer in trust by X, with the income payable to his son A for life, remainder to A's then living issue, ~ stirpes. Upon A's death the trust property would not be subject to a transfer tax to the extent it passes to the son's children but would be subject to tax to the extent it passes to A's grandchildren (X's great-grandchildren) because a child of A predeceased him. A long term trust continuing after the death of son A with contingent interests in A's issue would be subject to tax upon A's death. If the income were payable to son A for life, then to A's issue, ~ stirpes, living from time to time until the death of all of A's descendants living at the creation of the trust (including some grandchildren of A), remainder to A's then living issue, per stirpes, the entire trust property would be subject to tax upon the death of A. The trust would also be subjected to tax at a later time, such as the final distribution, to the extent the trust property passed to a descendant more remote than a grandchild of A. The theory underlying the Statute is that it is not necessary to determine at the time of a transfer in trust that a particular generation' may be skipped. It is only necessary to determine when that -91- PAGENO="0175" 161 generation is actually skipped The latter approach is clearly advisable because it is consistent with the trend in trust dispositions towards flexibility by permitting discretionary powers until the death of a beneficiary of the trust whose descendants may receive benefits in the trust after his death No attempt is made to dictate terms which must be contained in a trust instrument or to restrain a transferor in establish- ing a flexible trust plan through discretionary powers The trend toward flexibility in trust arrangements is desirable and should not be discouraged by a tax statute imposing rigidity on or stringent requirements for trusts. Professor A. James Casner recognized the importance of flexible trust dispositions when he stated: "Trusts which contain appropriate powers that enable beneficiaries to be determined from time to tine are adaptable to meet the changing picture of the trust property and of beneficiary needs. Flexi- bility in conferring benefits under a trust is more likely to make it possible to meet current problems adequately than any fixed and rigid plan formulated in either the recent or ancient past. * * * "It should also be apparent from our dis- cussion that the present tax laws do make power arrangements, as well as fixed and rigid trusts, more attractive than outright transfers As I have said I am opposed to a solution that treats mere power arrangements as the equivalent of out- right ownership because that will simply drive trusts into the rigid and inflexible pattern. I think the only sensible solution is to narrow the gap that now exists by limiting the time that both power arrangements and rigid trusts can keep some- one from being treated as the owner of the trust property for tax purposes." 25 Record of the Ass'n of the Bar of the City of New York, 62 at 63, 77~ (1970) The Statute does significantly narrow the gap by shortening the period during which trust property nay avoid transfer tax from as much as 100 years to one generation. The real test of any generation-skipping proposal is its handling of the discretionary trust where for example, the trustee is authorized to distribute income or principal among the grantor's descendants living from time to time and to accumulate any income not so paid. Solutions that -92- PAGENO="0176" 162 have been tried or proposed for discretionary trusts have been found ineffective or would create administrative complexities. See Shoup, Federal Estate and Gift Taxes, at 46-49 (1966). The Statute recognizes that there are desirable social purposes to be served by a discretionary trust and does not penalize the flexibility during the lives of persons who are beneficiaries (or possible beneficiaries) and are no more than one generation below the transferor, but creates an irrebutable tax presumption that if the trust continues after the death of such persons it is motivated more by tax considerations than by other purposes. The Statute applies to a transfer in trust or its equivalent Although this word is not used in the Statute but only in the heading, it is intended that the Statute apply to arrangements that are substantially the same as a formal trust. Illustrations of an "equivalent" would be an insurance - settlement arrangement or an employment compensation agreement providing for benefits payable to other persons. It is contem- plated that the Commissioner would issue regulations as to the meaning of this word pursuant to the authority granted to him by subsection (e). Several Supreme Court cases have discussed the constitutionality of the imposition of an estate tax in connection with the shifting of incidents of ownership in property as a result of a decedent's death. These cases, and particularly Fernandez v. Wiener, 326 U.S. 340 (1946), indicate that Sections 8 and 25 would raise no constitutional problem. There are five steps which nay be required in determining the application of the Statute. First, it is necessary to ascertain whether the individual involved who has an interest in a trust is a "beneficiary" as defined in subsection (c) (1). If he is a beneficiary, it is then necessary to determine if propertysubject to the trust passes to his descendants as a result of a "termination" or "distribution", as defined in subsection (c) (3). If it does, the next step is to determine whether the transfer is an "excluded trans- fer" under subsection (c) (8). If it is not, a determination must then be made as to the precise amount passing to the descendants under subsection (c) (7); this amount is subject to tax. Finally, if there is no inclusion under the fore- going steps and a "distribution" is involved, subsection (d) must be considered to see if it is applicable. General illustrations indicating the application of the Statute to common types of trust d~SpO~jtj0~5 follow the detailed discussion below. -93- PAGENO="0177" E Detailed Analysis o~ Statute 1 Subsection (a) - General Rule This provision states the general rule - the value of property passing to a beneficiary a descendants upon a termination or distribution is a transfer by the beneficiary that is subject to transfer tax Thus a succession tax approach is used Section 8 applies to lifetime passing and Section 25 to passings at death The key terms used in the general rule are defined in subsection (c) There are two exceptions to the application of the general rule. First, it does not apply to the extent the trust property is otherwise subject to tax under the chapter. This avoids the possibility of a double tax on the trust property. Second, the general rule does not apply to the excluded transfers contained in subsection Cc) (8). Thus, the framework is a general rule of broad application, but restricted in scope by the granting of exemptions for certain limited types of transfers. 2. Subsection (b) and subsection (a)(2)of Section 43 - Computation and Payment of Tax. The tax imposed by the Statute is computed under the general provisions of the transfer tax. Therefore, the property includible in gross transfers is subject to the other transfer tax provisions, such as credits and deductions. Thus, for example, if an included transfer is involved the gross estate would be increased for the purpose of computing the maximum available marital deduction. Payment of the tax from the property which is subject to the tax is required absent a contrary election in the case of a lifetime transfer or a contrary will pro- vision in the case of a transfer at death The tax to be paid from the trust property is the difference between the tax actually payable and the tax that would be payable if the Statute were not applicable This marginal rate al- location patterned after the method of computing the deduc- tion under current section 691 Cc) for the estate tax on income in respect of a decedent minimizes the effect of the inclusion of the trust property in the beneficiary s gross transfers insofar as his own property is concerned -94- 163 68-872 0 - 76 - 12 PAGENO="0178" 164 3. Subsection Cc) - Definitions. As mentioned previously, the definitions in sub- sections Cc) Cl) through Cc) (8) set forth the meanings of terms used with reference to subsection (a). Although the approach is apparent from the general rule set forth in subsection (a), it is only after the definitions are mastered that the precise scope and impact of this rule may be understood. Subsection (c) (8), relating to excluded transfers, is particularly important. a. Subsection (c) (1) - Beneficiary. A key definitional provision is the word `beneficiary." It is defined broadly to mean any person who, immediately prior to a termination or distribution, is entitled to receive pro- perty subject to a transfer in trust or is a permissible recipient of such property pursuant to the exercise of a power held by any person. Since this definition uses other defined terms - "termination", "distribution" and "power" - reference must be made to those definitions for a full understanding of the scope of subsection Cc) (1). A person who has an interest in a trust which is such that he is subjected to tax under other provisions of this chapter (a "transferor" as defined in subsection (c) (5)) is excluded from the definition of beneficiary with respect to the property so taxed. Illustrations of sit- uations where the person would be a beneficiary but for the exclusion are a trust where the person retains the income for life (Section 21) and a trust where the person involved has a general testamentary power of appointment with respect to the trust property (Section 22). Subsection (c) (1) also excludes from the definition of beneficiary a person who succeeds to a beneficiary's interest by means of an assignment. Such an assignment can arise only in the context of a lifetime transfer. If the beneficiary receives consideration in money or money's worth, the assignee is in reality a purchaser for value and should. not be considered a beneficiary. If the assignment is gratuitous, the beneficiary will be liable for payment of a transfer tax by reason of the assignment under other provisions. In either case, it is not appropriate to treat an assignee as a "benefi- ciary." This treatment contrasts with that accorded an assignee under the definition of the term "descendant", but is consistent with the purposes of the specific subsections: here, to exclude an inappropriate class from the category of beneficiary; with respect to descendants, to insure that the Statute cannot be avoided through an assignment of an interest held by a descendant to one who is not a descendant. Also, in -95- PAGENO="0179" 165 order to prevent avoidance, any assignment by a person interested in a trust is ignored in deternu.ning whether he or she is a beneficiary Although the definition of a beneficiary is broad it does not cover all possible trust beneficiaries For example assume that X created two trusts for his Sons A and B with income to the son for l~fe with the remainder distributable upon the son s death to the son s issue then living, per stirpes, and with a "cross-over" to the other trust or~E1ce other son's issue then living if A or B dies without issue. Each son and his issue have a contingent interest in the other son's trust. Also, each son's own issue have a contingent interest in their father's trust. Since neither A's own issue B nor B s issue will have an interest in A's trust during A's life, if one of this group should predecease A he will not be a beneficiary under subsection (c) (1) with respect to A S trust A will of course be a beneficiary If in the illustration the trustee of A's trust had authority to distribute income or principal to A or A's issue living from time to time, each such issue would be a "beneficiary". Thus, if one of such issue predeceased A leaving surviving issue it would be necessary to fit within one of the excluded transfer provisions to prevent the trust being included in such deceased issue s transfers at death The term "beneficiary" includes a "permissible recipient of property pursuant to the exercise of a power as defined in subsection (c) (4) This raises the question of how the term beneficiary is to be interpreted in con- nection with contingent rights or powers Although the importance of this issue is considerably reduced by the limited nature of the excluded transfer provisions it still must be dealt with. Treas. RegS. §20.2038-1(b) states: However section 2038 is not applicable to a power the existence of which was subject to a contingency beyond the decedent s control which did not occur before his death (e g the death of another person during the decedent s life) See however section 2036 (a) (2) for the in- clusion of property in the decedent s gross estate on account of such a power." See also Estate of Cyrus C Yawk~y 12 T C 1164 (1949) The intention is to have the case law and regulations under section 2038 apply in connection with contingent rights -96- PAGENO="0180" 166 or powers, except that a person to wham payments may be made pursuant to the exercise of a power limited by a determinable external standard is to be treated as a "beneficiary" whether or not the power is actually exercisable. See subsection (c) (4). To illustrate, if a trust provides that income or principal may in the trustee's discretion be paid to A if needed for support or maintenance, A will be a "beneficiary" even though at the time of his death A has sufficient property of his own to satisfy his needs for these purposes and therefore the power is not exercisable The following illustrations indicate how the definition of a "beneficiary" would apply regarding con- tingent rights or powers 1. Case 1 - two trusts, X and Y, are created. Trust X provides that income is to be paid to A and gives the trustee a discretionary power to pay principal to A. Trust Y provides that the trustee may pay the income or principal to A if Trust X is exhausted. At A's death Trust X has not been exhausted. A is a "beneficiary" as to Trust X but not as to Trust Y. 2. Case 2 - same as Case 1, except that A has an unlimited right of withdrawal over Trust X A is a beneficiary as to Trust Y as well as Trust X because his interest in Trust Y is môt subject to a contingency beyond his control 3 Case 3 - Trust X provides that A will be entitled to the income if he marries a girl of a certain religious faith. At A's death he has not so married. A is a "beneficiary" because his interest is subject to a contingency within his control. 4. Case 4 - Trust X gives A a non-cumulative annual power to withdraw the greater of $5,000 or 5% of the trust principal (see Section 22), or any person the right to distribute principal to A, but no other interest. A is a `beneficiary" because he is a permissible recipient of property subject to a power. 5. Case 5 - Trust X gives the trustee the right to pay income or principal to A's descendants living from time to time and states that income or principal may be paid to A if the original trustee resigns. The original trustee is A's wife B. While B is a trustee A is not a "beneficiary". -97- PAGENO="0181" .167 6. Case 6 - Trust X gives the trustee the right to pay income or principal to A's descendants living from time to tine and gives A's father, C, a special testamentary power of appointment (including the right to appoint to A) over the trust property as it exists on C's death. A pre- deceases C. A is not a "beneficiary" because the special power was not exercisable at A's death. The power was only exercisable at C's death. b. Subsection (c)(2)- Descendant. As previously noted, subsection (a) is applicable only if property passes from a beneficiary to his "descendants". The term "descendant" is defined broadly to include issue in any degree of the beneficiary and issue in any degree of any spouse of the beneficiary and spouses of such issue. The words "any spouse of the beneficiary" are intended to include a person who was a spouse at any prior time even though this relationship did not exist while the "beneficiary" relation- ship existed. To illustrate, if A by his will creates a trust with the income payable to his second wife, W, and the remainder payable upon her death to his issue by a prior marriage, such issue are "descendants" of W in applying the Statute. The reason for including spouses of issue is to prevent the avoidance of the Statute by creating trust remainder interests in spouses, such as a spouse of a great-grandchild. Adopted issue are included as descend- ants, but a proviso has been added to make it clear that the generational identity of a descendant will not be altered through adoption. Thus, a relative who is not a descendant, or a stranger, may be brought into the family line through adoption, but a great-grandchild, for example, of a beneficiary cannot be raised to the level of a child or grandchild of a beneficiary through adoption. Subsection (c) (2) treats any person who succeeds to the interest of a descendant by means of an assignment as a descendant. Thus, for example, an assignee of a re- mainder interest previously held by a great-grandchild of a beneficiary is considered as a descendant of the bene- ficiary. This prevents evasion through the use of assignments for consideration to persons not otherwise descendants of a beneficiary. The scope of the provision is, however, broader in that it would also apply to assignments involving no con- sideration. In other words, the rule is that any person taking through a descendant is deemed to be a descendant. -98- PAGENO="0182" 168 c. Subsection (c°) (3°) Termination and Distribution The Statute applies to the value of property passing to a beneficiary's descendants upon a termination or distribution Since a termination or distribution triggers the application of the Statute the scope of these terms is of primary importance Termination is defined to mean any occurrence, other than a "distribution", whereby a person who is a beneficiary immedIately prior to the occurrence ceases to be such. In most cases, death will be the terminating event. Distribution iS defined to mean a transfer pursuant to the terms of the governing instrument whereby property ceases to be a part of the trust. "Distribution" refers only to outright transfers or their equivalent and not to cases where the property is retained in further trust. If upon the death of A the trust property is to be divided into separate shares to be held in further trust, the death of A would be a termination rather than a distribution even though new trusts were created. The exclusion of a payment of current income from being considered as either a "termination" or a "distribution" is a rule of convenience which makes the Statute much easier to administer and which limits the cases where the same payment is subject to both income tax and transfer tax to those involving the throwback rule, a point that is discussed in detail below. The words "current income" are meant to include not only income earned during the trust's year in which the distribution is made hut income distributed after the close of that year as to which the trustee files an election under current section 663(b) Income is to be given the meaning set forth in current section 643(b) and Treas. Reg. §l.643(b)-l. The trustee's labeling of a particular payment to a beneficiary as being made from income or principal would be determinative in applying the "current income" rule. Two terms - termination and distribution - have been used rather than including a distribution as. a part of the definition of termination in order to simplify some of the other provisions namely the value of property passing to a descendant and the excluded transfers.. When the occur- rence of an event, such as the death of A (the income benefi- ciary of a trust) causes A to cease to be a beneficiary and a distribution of the trust property a distribution rather than a "termination" is involved. A distribution may also occur during the trust term by a payment of principal. Assume, for example, that X creates a trust, with one-half of the income to be paid annually to each of his -99- / PAGENO="0183" 169 children, A and B In A's case, the income interest 1.s to continue for. his. life., with one'-half of the remainder to his issue, per stii~pes, then living with respect to B how- ever, the income in~Ei~est is to cease after 25 years, with one.~half of the remainder to his issue, per stirpes, then living. A's death - which causes a payment of trust princi- pal - will be a distribution. If A assigns his entire income interest, the assignment will not be a termination because A continues to be a beneficiary. See the definition of "benefi- ciary" in subsection Cc) (1). The cessation of B's income interest after 25 years will be a distribution. If X creates a trust, with so much of the income and principal to be paid to A and his descendants living from time to time as the trustee in his discretion determines, remainder to A's issue per stirpes living at the death of the survivor of A and his children, the death of A would result in a termination. The same result would follow upon the death of any of A's children, except the survivor when a distribu- tion would occur. If the trustee exercises his power to pay principal to A or any descendant of A, the payment would be a distribution. With respect to each of the above illus-, trations, however, whether the termination results in an included transfer will depend on other factors, involving the other definitional provisions and particularly those relating to excluded transfers. For example, although a payment of principal to. A would be a distribution no property would pass to A s descendants and therefore there would not be a transfer subject to tax On the other hand, if a pay- ment of principal were made to a descendant o.f A, there would be an included transfer unless the excluded transfer provision relating to distributions were satisfied. Every cessation of an interest of a beneficiary in a trust will not':be a "termination". .To illustrate, if trust income is to be paid to A for ten years after which time the trustee is given discretion to pay income to A o.r his descend- ants living from time to time A S income interest ceases at the end of the ten year period but no termination occurs because A remains a beneficiary as a result of the trustee s discretionary power to distribute income to A If on the other hand at the end of the ten year period the income became payable to A s children and the trustee had no dis- cretionary power to pay income to A a termination wouid occur as to A upon the expiration of the ten year period Similarly, if all trust income is to be paid to A for five years and thereafter he is to receive only one-third of the income there is no termination as to A upon the expira- tion of the five year period. This result does not permit avoidance of tax because the amount taxable bears no relationship to the nature of the beneficiary s interest at termination -100- PAGENO="0184" 170 d. Subsection (c) ~4) - Power The term "power" is defined broadly to include an authority to do any act in relation to a beneficial interest in property. It encompasses powers held by any person, including a trustee and includes discretionary powers to distribute income or principal even though the exercise is limited by a fixed or ascertainable standard which prevents the current exercise of the power. e. Subsection (c) (5) - Transferor. The term "transferor" is defined to mean any person to the extent that property is deemed to be transferred by him pursuant to the provisions of the transfer tax. The creator of a trust is, of course, a transferor. Also, when an amount is subject to tax under the Statute upon the termination of a beneficiary's interest, that beneficiary is considered a transferor with respect to such amount. The term "transferor" is used only in certain of the excluded transfer provisions o~ subsection (c) (8), in subsection (c) (6), which is rele- vant in connection with the excluded transfer provisions, in section Cc) (1) so as to exclude such a person from the definition of a beneficiary and in subsection (d). If any part of a trust is included in the gross estate of an individual, that individual replaces the original transferor as the "transferor" with respect to the future application of the Statute. To illustrate,, assume that X created a trust to last until the death of the survivor of his son A and his son's wife, with the income and/or principal to be paid in the discretion of the trustee to A, his wife or his descendants living from time to time, with any income not so paid to be accumulated, and with A having a right to with- draw in each year 5% of the trust principal. Upon A's death, 5% of the trust principal will be included in his gross trans- fers and he will become the "transferor" as to this percentage of the trust principal. If thereafter during the life of A's wife a principal payment is made to a grandchild of A, 95% of such payment will be treated as coming from the original transferor and will be an included transfer and 5% will be treated as coming from A and will be an ex- cluded transfer. If A's right of withdrawal was over a fixed dollar amount, this amount will be converted into a fraction of the trust principal for the later application of the Statute. f. Subsection Cc) (6) - Member of the Same Generation. It is usually not difficult to determine whether a particular person is a member of the same generation as another -101- PAGENO="0185" 171 person when the persons involved are descendants of a close con~non ancestor In other cases particularly when the persons are not blood relatives, the problem is more difficult Sub- section Cc) (6) resolves this problem by providing that a per- son who is no more than 25 years younger than the transferor is deemed to be of the sane generation as the transferor Des- cendants of a grandparent of the transferor or of a beneficiary as the case may be, are excluded from this 25 year rule g Subsection Cc) (7) - Value of Property Passing to a Descendant Leaving subsection Cd) aside for the moment the Statute is applicable if trust property (including accumulated income but excluding current income) passes to a beneficiary S descendants Absent such passing there is no generation- skipping and therefore no reason to include the trust property in the beneficiary s qross transfers It is only generation- skipping or more precisely the splitting of trust benefits between generations that is the evil at which the Statute (other than subsection (d)) is directed. In determining whether property passes to the bene- ficiary's descendants, a doctrine similar to the reciprocal trust doctrine is required to prevent temporary avoidance by crossing remainder interests viz giving the descendants of one child the remainder interest in another child s trust A statement in the legislative history as to what was intended particularly in the light of the recent Supreme Court decision in Estate of_Grace v United States 395 U 5 316 (1969) and the delegation of authority i~iubsection (e) for the issuance of regulations to effectuate the purpose of the Statute should be sufficient to avoid any loophole in this regard It is contemplated that the regulations would specifically deal with and prevent a less blatant way of minimizing the effect of the Statute - creating separate trusts for each child and having the trust property distributed on the death of each child to all descendants of the creator rather than to only descendants of the deceased child The significance of avoiding a tax under subsection (a) is substantially lessened by the fact that subsection (d) makes it impos- sible to avoid the application of the Statute - if sub- section (a) is not applicable subsection (d) will produce a tax upon a subsequent distribution Subsection Cc) (7) states the manner in which the value of the property passing to the beneficiary s descendants is determined separately for a distribution or a termination In either case the value of the property passing to the bene- ficiary's descendants is, under subparagraph (C), not to be reduced by reason of the tax imposed under the Statute. The -102- PAGENO="0186" 172 actual value of the property passing to the beneficiary's descendants upon a distrLbutton is, under subparagraph (A), subjected to transfer tax As previously noted, a transfer to another trust is except in the limited cases referred to in subsection (c) (8) (C), not treated as a distribution but rather as a termination. Subsection (c) (7) (B) is applicable to termination valuations. Subsection Cc) (7) (B) (2) applies to a continuing trust which is subject to a power (as defined in subsection (c) (4)) held by any person. In determining the amount that may pass to the beneficiary's descendants a maximum exercise (or nonexercise) of the power in favor of his descendants is assumed. Thus all doubts are resolved in favor of the federal revenue To illustrate if the trustee is given the power to pay income or principal among a class consisting of the transferor s descendants living from time to time the entire trust property will be considered as passing from a child to his descendants upon child's death because the trustee may exercise the power entirely in favor of such descendants. To the extent that subsection Cc) (7) (B) (2) does not apply, subsection (c) (7) (B) (1) provides that the value of property that would be distributed to the beneficiary's descendants as a final distribution, if the trust became distributable at the termination, shall be included in the term value of property passing to a descendant Thus for example if a trust were to continue after a termination and the trustee does not thereafter possess any discretionary power over the disposition of the trust property the amount included under this subsection is the value of the interest that would have passed to the beneficiary's descendants if the trust had become distributable on the date of termination In a few cases the beneficiary's descendants may not be entitled to any part of the trust principal at the time of final distribution but will have interests in the trust after the termination and prior to such distribution This would occur when the descendants of the beneficiary were the recipients of a charitable remainder trust. See current section 664. Subsection Cc) (7) (B) (1) covers such a situa- tion by treating the full value of the trust property as passing to the beneficiary s descendants The beneficiary would, 1~owever, be able to claim a charitable deduction for the remainder interest in the trust. Another possible approach would be to create a separate excluded transfer provision for charitable remainder trust terminations or distributions The issue is of limited significance be- cause it will be extremely rare when a person two genera- tions below the transferor is made a beneficiary of such a trust. The value of property passing to descendants of the -103- PAGENO="0187" 173 beneficiary at a termination is pursuant to the last sentence of subsection (c) (7) (B), reduced by the value of any considera- tion in money or money s worth received by the beneficiary as a result of the termination This will occur only in connection with a volitional assignment by a beneficiary during his life * To illustrate a beneficiary may sell his income interest for cash Since amounts received by the beneficiary will become part of his estate and be subject to the transfer tax no tax avoidance is possible Although there may be a post- ponement of tax until the death of the beneficiary this re- suit does not seem objectionable since the descendants pos- session of the trust property will be postponed until the death of the assignor-beneficiary. The term "consideration in money or money's worth" is taken from the present estate and gift tax laws and regulations. See e.g., sections 2043(a) and 2512(b). Subsection (c) (7) (B) assumes that the trust property becomes distributable at termination or the power is exercis- able at termination These assumptions are inappropriate in valuing the property passing to a beneficiarY s descendants when a fully vested interest or interests of persons other than the beneficiary's descendants take effect immediately upon the termination To illustrate assume that income is payable to A then to B and then to C and upon the death of the survivor of A B and C the trust property is to be distri- buted to A s descendants It would be improper to include the full value of the trust property as passing to A's descendants upon his death if B or C survives him In such a case the value of the property passing to the beneficiary s descendants is reduced by the value of the outstanding income interests Normal valuation rules are to be applied in valuing such interests See Treas Regs §S20 2031-7 and 25 2512-5 The word outstanding is taken from Treas Pegs §20 2036-1(a) Before leaving the valuation provision, it should be emphasized that the valuation of the property passing to a beneficiarl s descendants upon a termination or distribution which controls the amount treated as a transfer under the Statute bears no relationship to the beneficiary s interest in the trust To illustrate if A is to be paid one-half of the trust income and the other one-half is to be accumulated or paid to individuals who are not A s descendants and upon A s death the entire trust property is to be distributed to A s descendants the value of the property passing to A s descendants is the full value of the trust property even * The assignor will remain a beneficiary after the assignment. See subsection (c) (1). -104- PAGENO="0188" 174 though A received only one-half of the trust income. The same result would follow if A were merely a possible recipient of income or principal through the exercise of a discretionary power. It nay be argued that this result is not "fair" * The answers to this contention are that fair- ness is produced by the. excluded transfer provisions of sub- section (c) (8) and any rule basing the amount treated as a transfer upon the nature of the beneficiary's interest in the trust would cause additional complexity. Also, in most cases there will be a direct relationship between the amount treated as a transfer under the Statute and the beneficiary's interest - the beneficiary will be entitled to all incone of the trust or will be a permissible recipient of all income. h. Subsection (c) (8) - Excluded Transfers. (1) Introduction If the Statute contained no excluded transfer provi- sions the value of all property passing to a ~beneficiary s descendants would be included in his gross transfers and would be subject to tax The excluded transfer provisions prevent this result by excepting certain specific types Of terminations and distributions from the operation of the Statute. They are of three types. First, there is an exclusion (paragraph (A)) for transfers in trust made before the enactment of the Statute Second there is a termination exclusion (paragraph (B)) separately stated for descendants and collaterals Two other termination exclusions relating to disclaimers (Section 16) and transfers for full considera- tion (Sections 3 and 18) are located elsewhere in the Draft Third, there is one "distribution" exclusion (paragraph (C)). ?aragraphs (B) and (C) are simple in concept and easily understood. Taken collectively, the exclusions permit an individual to establish a flexible scheme for the disposition of trust property among his "family" without having to worry about satisfying technical rules that' signi- ficantly limit the utility of the trust device Consideration was given to applying the Statute only to distributions as contrasted to terminations If this were done the Statute could he simplified and shortened Such an approach was rejected because it would encourage the use of long term trusts measured by the rule against perpetui- ties so as to avoid a transfer tax on the trust property for as long as possible. Any legislative solution to the genera- tion-skipping problem should not encourage the use of such trusts but rather should, insofar as possible, be neutral as between -105- PAGENO="0189" 175 long-term and short-term trusts (2) Subsection (c) (8) (A) - Transitional Rule This provision establishes a transitional rule regarding the application of the Statute to pre-existing trusts and bearing in mind that the word transferor is defined in paragraph (5) of subsection (c) it is that the Statute will not apply until the trust property is included in the transfers of an individual under another provision of the Draft This is the sane approach as is taken in the Studies (page 401) and the ALl Project (pages 54-55) The operation of the transitional rule may be illustrated as follows based upon the enactment of the Draft effective January 1 1974 Assume a trust was created in 1965 with income payable to A the grantor s son, for his life, and thereafter to A's issue living from time to time until the death of the last survivor of A s descendants living when the trust was created and~with the principal then to be distributed to A's living issue, ~ stirpes Upon A's death in 1975 subsection (c) (8) (A) will be applicable and the trust property will not be subject to Section 25 -- the property will not he includible in A s transfers at death because no other section of the Draft will be applicable to the trust property and thus A will not be considered a transferor within the meaning of subsection (c) (5) Similarly the property will not be taxed upon the death of any of A $ children The result would not be different if A had in addition to his income interest a special power of ap- pointment or any other interest or power which did not result in the inclusion of the property in his transfers under any other section of the Draft If A held a general testamentary power of appoint- ment over the trust property, that property would be included in his transfers at death pursuant to Section 22(b) (1) of the Draft A would accordingly be deemed a transferor of the property and the exception of subsection (c) (8) (A) would no longer be applicable The same result would occur if A s power is a special power of appointment which is taxed in his transfers under current sections 2041(a) (3) and 2514(d) relating to appointments which unduly postpone vesting owner- ship or an absolute power of alienation in a beneficiary To sum up after property held in trust prior to the effective date of the Draft is included in an individual s transfers under a provision other than the Statute it is subject to the Statute until such time it is not -106- PAGENO="0190" 176 (3) Subsection (C) (8) (B) (i) and (ii) - Terminations During Fixed Terms. Subsection (c) (8) (B) (i) and (ii) describe termina- tions which are exempt from the application of the general rule in subsection (a) A liberal termination rule is appropriate bearing in mind that distributions are treated separately. Only one limitation is placed upon the use of a trust term measured by multiple lives of persons who are no more than one generation below the transferor. It is that immediately after a termination each person who is used to a measuring life is a beneficiary and at least one of such persons is no more than one generation below the trans- feror. The nature of the beneficiary's interest is, however, irrelevant. It is inappropriate to create an excluded trans- fer provision measured by the life of a person who is not a beneficiary since except in rare cases there is no reason to create such a trust other than to postpone the payment of the tax as long as possible. The exception is inapplicable to trusts whose duration is measured solely by a term of years. There are two permitted classes of measuring lives, one relating to descendants - (i) - and the other to collaterals - (ii) -, With ancestors and the transferor's spouse included in each class. The words "prior to" rather than "no later than" have been used to insure that upon the death of the last measuring life the termination exception will not apply (4) Subsection (c) (8) (C) - Distributions Under this subsection outright transfers of property to a child or grandchild of the transferor are excluded from the operation of the Statute The last sentence of this sub- section permits certain specified dispositions in further trust for a grandchild to be treated as an outright distribu- tion to the grandchild In order for the trust disposition to be treated as an outright transfer, the grandchild must, sub- ject to one exception, be the sole beneficiary of the trust and be treated as the "owner" of the trust property for pur- poses of the transfer tax under other provisions of the chap- ter. The exception permits vesting of the trust property in the grandchild under other transfer tax provisions to be postponed until he attains an age not to exceed 35 years There are a considerable rumber of cases in which grantors desire to postpone vesting of trust property upon a child s death, in a grandchild until the attainment of an age in -107- PAGENO="0191" 177 excess of 21. Use of age 35 will cover most of these cases. Although postponement of vesting may be obtained to any age by giving the grandchild a general power of appointment, many grantors do not want to give the grandchild such a power. The objection is not based upon tax considerations (the grandchild will in almost all cases attain the desired age) but rather upon the fact that the general power gives the grandchild complete control over the property at death under the stated age and the grantor wants to avoid such control until the grandchild attains an age which is con- sidered mature enough to assume that the power will be exercised "wisely'. Under subsection (a) , if the grandchild in whom the vesting is postponed should die before reaching age 35, there will be a termination or distribution at that time and the trust property will be subject to transfer tax at that time unless no property passes to his descendants. Thus, in the case of the death of a grandchild under age 35, the exception does not permit avoidance of tax, but rather only postponement of the tax until his death. 4. Subsection (d) - Trust Transfers Not ~ubject to Subsection (a) Subsection (d) is directed at situations that will arise only infrequently - where because of the failure of issue or an unusual order of deaths a person receiving a distribution did not have an ancestor who was a beneficiary immediately prior to the distribution or where the trans- feror might desire to make an unnatural disposition in order to avoid the other provisions of the Statute. Subsection (d) makes it impossible for any distribution of trust property to a person more than two generations below the transferor to avoid the application of the Statute. A few examples will illustrate the scope of sub- section Cd), which applies to distributions but not to terminations: Example 1 - unusual order of deaths - if X creates a trust for his son A s life with the income to be paid to A and the principal to be distributed upon A s death to his then living issue ~ stirpes and a child of A predeceases A leaving issue who survive A, the value of the property passing to such issue will be an included transfer by A Similarly if X creates a trust to continue until the death of the survivor of his children with the income payable to his issue per stirpes living from time to time and with the principal t6~e distributed to such issue living at the termi- nation of the trust and the last surviving child A has a -108- PAGENO="0192" I 178 child who predeceases A leaving issue living at the termina- tion, the property passing to such issue is an included transfer by A. If, however, A was not the last surviving child there would not, absent subsection (d), be an included transfer with respect to the property passing to A's issue because such issue are "beneficiaries" and no property passes to their descendants. Subsection (d) applies in such a case. Example 2 - death without issue - X creates a trust for each oUhis two sons A and B with the income to be paid to the son for life and the principal to be distributed upon his death to his then living issue, ~ stirpes, or, if none, to the other son's trust or, if the other son is not living, to his then living issue, ~ stirpes. A has no issue and B has two children, one of whom predeceased B leaving issue who survive B and A. Under the Statute, exclusive of subsection Cd), the property passing to the issue of the deceased child of B upon B's death is an included transfer by B but the property passing to those same issue upon A's later death is an excluded transfer because no property passes to a bene- ficiary's descendants. Subsection Cd) does, however, apply to the passing of the trust principal to the issue of the deceased child of B upon the death of A. Example 3 - "game playing" - absent subsection Cd) the Statute could be avoided by terminating a beneficiary's interest before the expiration of the period permitted for termination under subsection (c) (8) (b) Ci) or (ii) so that at the first termination subject to the Statute trust prop- erty would pass to a beneficiary rather than to his descen- dants. For example, assume that X created a trust to last until the death of the survivor of his children A, B and C and that until the death of the first two of his children the income is to be paid to his issue, per stirpes, living from time to time and thereafter until the d~eath of the sur- vivor of the children the income is to be paid to the grand- children of the two deceased children and the living child and upon the death of the survivor the trust principal is to be distributed to such grandchildren (great-grandchildren of X) and the surviving issue, ~ stirpes, of the last surviv- ing child of X. Without subsectióKTd), the property dis- tributed to the great-grandchildren of X would not be subject to tax because no property passed to the descendants of such great-grandchildren. The subsection prevents any abuse in this regard and applies to the distribution made to the great-grandchildren. Subsection Cd) would also apply to a mandatory accumulation trust with no "beneficiary". To illustrate, if X created a trust to continue until 21 years a~fter the -109- PAGENO="0193" 179 death of the last survivor of all his descendants living at the creation of the trust, at which time the trust property is to be distributed to his issue then living, ~ atir~es, and if at termination the property becomes dist±Ibutáhle to seven great-grandchildren of X, the subsection will apply to the entire trust property. When the person to whom the distribution of trust property is made had an ancestor who was a bene- ficiary of the trust, the tax imposed on the transfer could be based upon such ancestor's transfers by applying the theory of "once a beneficiary always a beneficiary". The difficulty with this approach is twofold. First, in some cases the ancestor will have died and opening up his final transfer tax return would be required. Second, and more important, in other cases it would not be avail- able because no ancestor was a beneficiary of the trust. For these reasons the approach was rejected and a simple accessions concept is applied in determining the amount of the transfer tax payable in connection with the trust distribution - the person receiving the property is deemed to have made a transfer to himself. An inclusion of something less than the entire value of the property that is distributed to the recipient is appropriate since the amount subjected to tax will increase his rate of tax on subsequent transfers and the property received by the recipient (reduced by the transfer tax) will be taxed a second time upon its transfer during life or at death. The percentage selected, 60%, seems reasonable bearing these factors in mind, but could, of course, be varied. The amount of the tax is determined as of the date of the event that causes the distribution. ~towever, a delay in payment is permitted for a "winding up" period of the trust by treating the transfer as occurring in the third calendar quarter commencing after such event. The amount of the transfer tax imposed upon or connected with a "tainted" trust disposition will vary depending upon whether the Statute (excluding subsection (d)) ~or that subsection is applicable. Generally speaking, the application of subsection (d) will he more severe be- cause the distributed property is both taxable as a transfer by the recipient and increases the rate applicable to his subsequent transfers, including a transfer of the same property. An illustration may be helpful. Assume that property having a value of $250,000 is distributed to a person who is treated as making a transfer to himself under -110- 68-872 0 - 76 - 13 PAGENO="0194" 180 subsection (d) and that such person has not made any prior transfers subject to the transfer tax. Such person would file a transfer tax return reporting a transfer of 60% of $250,000, or $150,000. His subsequent taxable transfers would be taxed from the base of $150,000 less any available exemptions. The approach of treating the recipient of a dis- tribution of trust property as making a transfer to himself should not create a problem in connection with subsequent transfers by him to his spouse While his transfer tax rate will be higher this rate is irrevlevant in connection with transfers that qualify for the marital deduction (Sections 15 and 32). Further, the transfer by the recipient to him- self will permit an increased marital deduction as to sub- sequent transfers where the minimum $250,000 figure is exceeded since it increases his transfers and the amount available under the limitation to one-half of his transfers. 5. Subs'sction (e) - Regulations. Subsection (e) specifically empowers the Treasury to promulgate such regulations as may be necessary to imple- ment the Statute. The regulations would deal with several matters not specifically set forth in the Statute that are mentioned above including the definition of the equivalent to a transfer in trust the crossing of remainder interests and the meaning of the term current income used in sub- section (c) (3). Also, when subsection (a) is applicable to two individuals at the same time the regulations would state that the subsection will be applied to the eldest ancestor or, put another way, to the nearest descendant of the transferor For example if a distribution is made from a trust to a great-grandchild of the transferor and both his parent and grandparent in his line of descent from the transferor are living the transfer will be deemed to have been made by the grandparent (the child of the transferor) rather than the parent. 6 Relationship with Throwback Rules In the case of a distribution taxed under the Statute the person receiving the distribution may be deemed to have received undistributed net income (UNI) or undistri- buted capital gain (UCG) that is subject to the throwback rules of sections 665 through 669. In the case of a termina- tion taxed under the Statute, a person later receiving a distribution from the trust may be in the same position. In either case, the same property would be subject to both trans- fer tax and income tax. Some adjustment is necessary in order -111- PAGENO="0195" 181 to prevent a second tax being imposed upon the full amount that is subject to the first tax. If this occurred, the two taxes could, depending upon the tax rates, exceed 100% of the value of the distributed property. Section 691 provides that if the same property is subject to both estate tax and income tax the recipient of such property is entitled to claim an income tax deduc- tion for the estate tax attributable thereto Property subject to both estate tax and income tax is referred to as income in respect of a decedent (or 691 income). The double tax problem caused by the application of the Statute and the throwback rules is handled in the same manner as 691 income. This is done by permitting a trust beneficiary who is deemed to have received UNI or UCG to claim an income tax deduction for the transfer tax (whether imposed under subsection (a) or (d) of the Statute) attributable to the UNI or UCG, determined under the "in- cremental" approach of section 691 (c) (2) (C) - the transfer tax attributable to the aggregate of the UNI and UCG is theY difference between the transfer tax actually paid and the transfer tax that would have been paid if an amount equal to the UNI and UCG had not been subjected to tax under the Statute The deduction provision would be inserted in subpart D as a new section 667(b) (2) (D) to read as follows If a transfer tax has been imposed upon trust property which includes undistributed net income or undistributed capital gain, pursuant to section (8 or 25] ,each beneficiary deemed to receive all or any part of such undistributed net income or un- distributed capital gain shall be entitled to claim a deduction for the transfer tax attributable thereto determined in accordance with the method prescribed in section 691 Cc) (2) (C) (relating to income in re- spect of decedents) and regulations prescribed by the Secretary or his delegate." A beneficiary deemed to have received UNI or UCG may alect to compute his tax on the throwback under either an exact method or a short-cut method If he uses the exact method he will claim his transfer tax deduction attributable to UNI or UCG for the same year or years in which the UNI or UCG thrown back was accumulated in the trust To illustrate if upon a distribution in 1980 there was a throwback to years 1970 and 1971 the deduction for the transfer tax would be claimed in the recomputation for those two years If, however the beneficiary uses the short-cut method the deduction will be prorated against -112- PAGENO="0196" 182 all throwback years, including those occurring after the imposition of the transfer tax. To illustrate, assume that a transfer tax of $50,000 is imposed upon a trust under section 25, of which $10,000 accumulated in 15 years; that after the imposition of this tax the trust accumulated $15,000 of UNI and $7,500 of UCG in 10 more years; and that a single beneficiary receiving all trust property at the end of the trust term elected to use the short-cut method. The number of years in which UNI or UCG was accu- mulated totals 25. This figure is divided into $10,000, the transfer tax attributable to UNI and UCG, to produce an annual deduction of $400 in computing the beneficiary's tax under the short-cut method for each of his three years immediately preceding ~the year of payment. A few other points concerning section 667(b) (2) (D) would be covered by regulations. The word "imposed" is intended to refer to the event causing the transfer tax and not the later time of payment of the tax. Second, only beneficiaries that receive a distribution simultaneously with the imposition of the transfer tax or thereafter may claim a deduction for the tax. In some cases a beneficiary may receive an accumulation distribution of UNI or UCG during a taxable year in which a later termination, as con- trasted to a distribution, under the Statute occurs. Such a beneficiary would not be entitled to claim any part of the deduction for the transfer tax since the property distributed to him was not subject to both transfer tax and income tax. Third, the deduction is to be allocated between UNI and UCG proportionately since each dollar of UNI or UCG generated the same transfer tax Thus the deduction per dollar of UNI or UCG will simply be the total transfer tax attribut- able to UNI and UCG divided by the aggregate amount of UNI and ULG in the trust when the transfer tax is imposed Fourth in determining this amount a look back approach would be used If an accumulation distribution is deemed to have been made to a beneficiary and later in the trust s same taxable year an event occurs causing the Statute to apply, the UNI and UCG will be adjusted from the cumula- tive UNI and UCG as of the close of the preceding taxable year to reflect any amounts of UNI or UCG deemed paid to such beneficiary as a result of such distribution. Fifth, although the deduction for the transfer tax attributable to UNI or UCG is to be determined in the same manner as the section 691(c) deduction, the distribution is not to he treated as 691 income to the extent that it is deemed to consist of UNI or UCG. This point is important in determin- ing the beneficiary's basis for the property distributed - the normal basis rules will be applicable rather than the special basis rule of current section 1014(c). -113- PAGENO="0197" 183 7. Exan~ples. (1) X creates a trust with income to his wife for life, remainder to his issue, ~ stirpes, who survive his wife. Any distribution upon the wife's death to a child or grandchild of X would be an excluded transfer under subsec- tion (a) (8) (C). Any distribution to a more remote descen- dant of X would be an included transfer by the wife regard- less of whether such descendant is an issue of hers. See the definition of "descendant" in subsection (c) (2). (2) x creates a trust with income to his wife for life, then to his issue, per stirpes, living from time to time until the death of the last to die of his children when the trust property will be conveyed to his then living issue, per stirpes. The terminations upon the wife's death and upon the death of each child (other than the survivor) would be excluded transfers under sub- section (c) (8) (B) (i). The distribution upon the death of the last surviving child would be an excluded transfer under subsection (c) (8) (C) or subsection (d) to the extent the trust property was conveyed to grandchildren of X, but an included transfer to the extent such property was conveyed to more remote descendants of X. Inclusion would be under subsection (a) in the case of a grandchild or more remote descendant of the last surviving child, who would be treated as making the included transfer, or under subsection (d) in the case of a grandchild or more remote descendant of any other child. (3) X creates a trust to last until the death of the survivor of his wife, his children and the spouses of his children, at which time the trust property is to be conveyed to his issue then living, ~ stirpes. During the trust term the trustee is authorized to pay income and/or principal among a class consising of X's wife, his descendants and the spouses of any deceased descen- dants living from time to time or to accumulate income. a. A termination by the death of the wife, a child, a child's spouse or a grandchild or more remote descendant of X prior to the expiration of the trust term would be an excluded transfer under subsection (c) (8) (B) (i) b. A distribution by a payment of principal to X's wife, a child, a grandchild or a spouse of a deceased child or grandchild would be an excluded transfer under subsection (c) (8) (C) or subsection Cd). c. A distribution by a payment of principal to -114- PAGENO="0198" 184 a great-grandchild or more remote descendant of X or a spouse of a deceased great-grandchild or more remote descendants of X would be an included transfer, even though the recipient was a nearest descendant, by right of representation of X, or a spouse of such descendant, at the time of the distribution. The distribution would be treated as a transfer by the great-grandchild s most remote ancestor who is a descendant of X and a beneficiary or, if there were no such ancestor, as a transfer under subsection (d). (4) Same case as 3 except the trust is to continue until the death of the survivor of X's wife and all of his descendants living at his death, including some grandchildren. Upon the death of the survivor of X's wife and the children, the entire trust property would be an included transfer and be deemed to have been transferred by such survivor since the entire trust property may thereafter be paid to the descen- dants of such survivor. Subsection (c) (8) (B) (i) is not ap- plicable, even though the trustee may thereafter distribute the entire trust property to X s grandchildren (5) X creates a trust with income to his wife for life Upon her death separate trusts are created for his children (or issue ~ stir~es of a deceased child) with income to the child1~r Individual issue) for life and the trustee having discretion to pay principal to an income beneficiary. Upon a child's death (or the death of an individual issue of a deceased child) the trust property is to be conveyed to the then living issue, ~ stir~es, of the deceased income beneficiary. The termin- ation upon the wife's death would be an excluded trans- fer under subsection (c) (8) (B) (i), except that if a child predeceased X's wife and a trust was created for a grand- child upon the wife's death, the termination upon the wife's death would be an included transfer by the wife to the extent of the property passing in trust for the grandchild since the grandchild is not a permissible measuring life. This result could be avoided by giving the grandchild a general testamentary power of appointment. The distribution upon the death of a child would be an excluded transfer under subsection (c) (8) (C) to the extent the property passes outright to a grandchild, hut an included transfer by the child to the extent the property passes to a more remote descendant. If upon the death of a child his trust was to continue for each of his children (grandchildren of X) until the child attained an age not to exceed 35 years, the disposition upon the death of the child of X would still be an excluded transfer under subsection (c) (8) (C), but -115- PAGENO="0199" 185 if the grandchild died under the age of 35 years and trust property passed to the grandchild s issue upon the grand- child s death there would be an included transfer by the grandchild to the extent of such property. (6) Same case as 5 except that if a spouse of a child survives the child the trust is. to continue for the spouse s life with the income paid to the spouse and upon the spouse's death the trust property is to be conveyed to the child's then living issue, per stirpes. The distribution upon the death of the spouse would b~ian excluded transfer under subsection (c) (8) (C) to the extent the property passes to grandchildren of Xbut an included transfer by the spouse to the extent the property passes to more remote descendants of X. (7) Same case as 5 except that the child is given a special power to appoint the trust property upon his or her death. a. If the child appoints the trust pr~perty out- right in any manner among his children the distribution on the child's death would be an excluded transfer under sub- section (c) (8) (C). b. If the child exercised his power by appointing the trust property in further trust during the life of his wife with the income and principal to be paid among a class consisting of his wife and his descendants living from time to time and any income not so paid to be accumulated and gave his wife a special power to appoint the trust property upon her death the termination on the child s death would be an excluded transfer under subsection (c)(8) (B) (i) since immediately after the child s death his wife (the measuring life) is a beneficiary. The fact that the wife may appoint in further trust upon her death is irrelevant in determining the application of subsection (C) (8) (B) (i) upon the child's death. c If the child exercised his power by appointing the trust property in further trust for his grandchildren during their lives with remainder to his great-grandchildren, the termination on the child's death would be an included transfer by the child but the distribution upon the later death of a grandchild to a great-grandchild would then be an excluded transfer under subsection (c) (8) (C) -116- PAGENO="0200" 186 Sections 9,13, and 21. Deferral of Transfer Tax cn Certain Inter Vivos Transfers. A. Introduction Under the current dual gift and estate tax laws, an inter vivos transfer involving retained rights or powers in the transferor may give rise to a gift tax upon the transfer and, under sections 2036, 2037 and 2038, an estate tax upon hi~ death. Section 2036 applies where the trans- feror retains an income interest in or the right to use the transferred property, or where he retains a right to designate the beneficiary to receive the income from or the use of such property. Section 2037 is applicable where possession or enjoyment of the property can be obtained only by sur- viving the transferor and the transferor retains a reversion- ary interest in theproperty exceeding, immediately prior to his death, 5% of the value of the property. Section 2038 requires inclusion in a transferor's estate of the value of an interest in property over which he retains a power to alter, amend, revoke or terminate. Double taxation of over- lapping transfers is avoided by allowing a credit under sec- tion 2012 against the estate tax for the gift tax The opera- tion of the credit is complex and in some cases illogical. Sections 9, 13 and 21 contain the Draft's approach to the important issue of the time of payment of the transfer tax upon transfers under which the transferor retains a limited interest in, or power over, the transferred property. They respond to Recommendation 23 of the ALl Project, which is (page 8) A line between completed and uncompleted gifts should be definitely established, so that all lifetime arrangements would fall on one side of the line or the other, and so that there would be no area where the same transfer is subject to transfer taxation both as a lifetime transfer and a deathtime transfer, under either a dual tax system or a unified tax." The objective is to establishclear rules assuring that a given transfer will be taxed only once and thereby eliminate the overlap and much of the complexity which exists under current law This necessarily involves taking a position on where the line should be drawn and whether a hard- to-complete" or "easy-to-complete" approach should be used. B. Elimination of Overlap. It is not easy to draft a statute insuring that -117- PAGENO="0201" 187 no transfer subject to a transfer tax during life would be subject to tax again at the transferor's death. Rules for lifetime transfers which operate independently of the deathtime provisions could create the possibility that such a transfer would be taxable when made and would also be an includible transfer at the transferor's death. At the same time, gaps might arise in coverage through which property could be transferred free of tax at both the time of transfer and upon the subsequent death of the transferor. After considering various alternatives, we believe the most satisfactory way of drafting the desired statute is by an interrelated provision which determines whether a lifetime transfer is complete or incomplete on the basis of whether the property would be included in the transferor's transfers at death if he died immediately after the transfer. If the property would be so included, the transfer will be deemed incomplete when made; if the property would not he so included, it is deemed complete and immediately taxable. Such an approach affords protection both to the taxpayer (from double tax) and the federal fisc (from no tax). The interrelation of the inter vivos and deathtine provisions described above will not~Ti~inate the possibility of double taxation under the Draft in all cases, which will continue where retained interests or powers of the trans- feror are not in existence immediately after the transfer but "spring up" at a later time. For example, assume a life- time transfer under which the transferor retains a life estate in the property to commence upon the death of another who is living at the transfer. This transfer is taxable under the Draft when made. If the transferor's life interest begins prior to his death, the property subject to his interest will be included in his transfers at death under Section 21. Section 35 provides a credit for the taxes previously paid in such cases, but only if the property has not been included in the transfers of any other person after the transfer and prior to the transferor's death. See the discussion of Sections 22(b) and 35. Such cases of double taxation should, however, be rare, and may be avoided through appropriate drafting in the instruments of transfer. C. "Hard-to-Complete" vs. "Easy-to-Complete" Rule. The time when a tax will be imposed on a lifetime transfer depends upon whether a "hard-to-complete" or an "easy-to-complete" rule is adopted, since the property is taxed only when the transfer is deemed complete for transfez~ tax purposes. Under Section 21, a "hard-to-complete" rule, drawing upon parts of present sections 2036 and 2038, is -118- PAGENO="0202" 188 established. The main distinction between these ~wo approaches is in the area of retained control over the disposition of property as contrasted to retained beneficial interests in property. Under the "easy-to-complete" rule only retained beneficial interests in property prevent the immediate imposition of a transfer tax, while under the `hard-to-complete" rule retention of control over the property will also preclude an immediate tax. The ALl Project (page 42) summarized the "easy-to-complete" rule as follows: "It would allow a transferor to retain many strings on a transfer and nevertheless get the value of the future growth out from under transfer taxation, as long as the strings do not permit the transferor to pull the property back to himself." From the transferor's viewpoint, this rule allows him to remove from his estate subsequent appreciation and income accumulated with respect to the taxed property, but he loses the use of the amount paid as tax at an earlier point in time. Both the Studies (pages 361, 363-65, 384-87) and the ALl Project (pages 41-44, 45-46, 188-90) recommend an "easy-to-complete" rule. We believe that as a policy matter such a rule is wrong. An individual should not be permitted to insulate future appreciation or income accumulations from transfer tax when he retains control over the transferred property. There is another reason why we oppose an "easy-to- complete" rule. It will involve changing present estate tax law which is now reasonably clear in its effect after many years of interpretation. Unless there is a provable ad- vantage to the "easy-to-complete" rule, the time spent in shifting from existing law to the new approach is an unproductive use of time and money. A shUt to an "easy-to-complete" rule is usually justified on one or both of two premises. We believe that each of the premises is incorrect. The first premise is that although we have struggled for many years to draw a line between complete and incomplete transfers, using a "hard-to-complete" approach, we have the skill to draw an easy-to-complete line which is free from doubt Our experience with tax law makes us doubt that this is true. A line between a taxable transaction and a nontaxable trans- action is always hard to draw. We should not abandon the knowledge which we have painfully acquired over the years regarding the hard-to-complete rule. -119- PAGENO="0203" 189 The second premise is that since all transfers will be subject to a single rate schedule even an imprecise dividing line will not be productive of controversy This is erroneous If an individual makes a lifetime transfer and the property appreciates in value it is to the Govern- ment s advantage to take the position that the transfer is a deathtime rather than a lifetime transfer Under exist- ing law increases in value between the time of transfer and the time of death more than rate differentials, cause the Government to challenge the time of completion of the transfer An easy-to-complete rule will not change this situation unless the law is drafted so that if an individual makes a transfer during lifetime and pays a tax, the Govern- ment is estopped from raising the question of the time of completion of the transfer for transfer tax purposes Absent such an objective test as to the time of transfer existing law is superior because of the knowledge acquired as to the time of transfer Further as a matter of sound tax administration we do not think that the Government should make such a concession We believe that a hard-to- complete rule is more satisfactory from the standpoint of sound tax administration than an easy-to-complete rule With respect to retained beneficial interests as contrasted with retained powers Section 21 also produces a result at odds with the easy-to-complete' rule Under this section the transferor s retention of a right to re- ceive the income from transferred property pursuant to the trustee s exercise of a discretionary power is sufficient to require inclusion of the property in his transfers at death Thus if an individual creates a trust with the trustee having a discretionary power to pay income (or principal) among a class consisting of himself and his descendants the trust property will not be taxed upon the creation of the trust but will be included in his transfers at death under Section 21 except to the extent that during his life payments of income or principal are made to his descendants, in which case the amounts of the payments are considered lifetime transfers by him. The Studies (pages 384-85) and the ALl Project (pages 130-36) would apparently treat the type of trust transfer referred to in the preceding paragraph as complete (and taxable) when made because the transferor did not re- tain an absolute right to the current beneficial enjoyment We believe this result is wrong and contrary to what is intended by most transferors in such a case Also not infrequently an individual will place his property in trust and give the trustee the discretion to pay the income to -120- PAGENO="0204" 190 himself or to accumulate it He does so to protect himself by placing the transferred property beyond his control but he has no intention of foregoing the benefits of the property and does not expect a transfer tax to be imposed upon the creation of the trust It is preferable to treat a retained right to income subject to a discretionary power in the same manner as a transfer with a retained life estate D Detailed Explanation of Sections As indicated Sections 9 13 and 21 are interrelated Section 21 establishes a rule that property transferred by an individual during his life will be included in his transfers at death if he retains certain rights in the property or certain powers over its disposition Section 13 creates a deduction for lifetime transfers which would be included in transfers at death if the transferor died immediately after the transfer - thus the transfer will not be taxed when made Section 9 also an inter vivos provision requires that property for which ~~u~ET6~ was allowed under Section 13 be included in the individual's transfers at anytime after the transfer and prior to his death when an event occurs by reason of which the property would not be included in trans- fers at death, such as a payment of income to another from a discretionary trust of which the transferor is permissible income recipient or the termination of a retained right or power in the transferor during his lifetime Through these sections an initial deferral of tax is provided under Section 13 where the transfer is deemed incomplete under the hard-to-complete rule of Section 21 but the tax is imposed either at a later tine in the transferor a lifetime when the transfer is deemed complete under that rule (Section 9) or upon the transferor a death (Section 21) Each of these sections is discussed separately below This discussion is followed by examples of the manner in which common disposi- tions would be treated 1 Section 21 a In General This section includes in the transfers of an individual at death the value of all property that he transferred and over which he retained (i) a right to receive the property or the income from or the use of the property or (ii) a power to determine who shall receive the property or the income from or the use thereof or the time of receipt It is intended to apply broadly to any retained right to a current benefit from the property and to any retained power to affect currently the beneficial enjoyment of the property. -~ 1- PAGENO="0205" 191 Certain charitable transfers where an interest is retained are excluded from the section by special rules, discussed below. Section 21 is a consolidation of sections 2036 and 2038. Section 2036(a) (1) relates to retained income rights and section 2036(a) (2) to retained income powers. The right or power must have been retained in the inter vivos transfer for a period related to the transferor's ~ t.hT"T~r his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death"), but the retention need not be express and may be pursuant to an understanding which is not legally enforcable. Treas. Pegs. §20.2036-1(a); Est. of McNichol v. Commissioner, 265 F.2d 667 (3rd Cir.) , cert. denied, 361 U.S. 829 (1959) Skinner v. United States ,D7 F. ~upp. 726 (E.D. Pa. 1961), aff'd, 316 F.2d 517 (3rd Cir. 1963). Section 2036 applies to contingent beneficial interests, such as a secondary income interest following an income interest in another person that is outstanding at the transferor's death. See Treas. Pegs. §S20.2036-l(b) (1) (ii) and 20.2036-1(b) (3) . Section 2036(a) (2) applies to a retained power exercisable alone or only with the consent of another person (including a bene- ficiary) and in an individual or in a fiduciary capacity. Neither section 2036 (a) (1) nor 2036(a) (2) applies to a re- tained "right" or "power" the exercise of which is subject to a fixed or ascertainable external standard. See, ~ Jennings v. Smith, 161 F.2d 74 (2d Cir. 1947) Section 2038, like section 2036(a) (2) , applies to powers held in any capacity by the transferor at his death, under which he may, acting alone or in conjunction with any person, alter, amend, revoke or terminate the enjoyment of any interest in property which he previously transferred. The power need not have been retained in the original transfer. It must, however, be in existence and exercisable at his death -- unlike section 2036 (a) (2) section 2038 is not applicable to a power whose exercise was subject to a contingency beyond the transferor's control which did not occur prior to his death. Treas. Peg. §20.2038-1(b). For example, if a power in the transferor to alter a trust were to come into existence only upon another's death and the transferor predeceased such other person, section 2038 would not be applicable. The section does, however, apply to powers affecting the tine or manner of enjoyment of property or its income, even though the identity of the beneficiary is not affected. Lober v. United States, 346 U.S. 335 (1953); Treas. Regs. §20.2038-1(a). Like -122- PAGENO="0206" 192 section 2036(a) (2), section 2038 does not apply to a retained power in the transferor whose exercise is limited by a fixed or ascertainable external standard. Sections 2036 (a) (2) and 2038 may both apply to a single power, but the amount includible under each section may be different. For example, if a transferor creates a trust and retains the power to alter the designation of the income beneficiaries, both sections 2036(a) (2) and 2038 will be applicable. Under section 2036, the full amount of the transferred property over which he retained the power to designate the distribution of income is includible in his gross estate. However, under section 2038 only the value of the interest subject to the power, rather than the entire value Qf the underlying trust property, is includible in his gross estate. Section 21 combines sections 2036 and 2038 by referring to both "income" (or "use") and "property", thus including within its coverage income arid principal interests. It continues section 2036 and applies to a right or a power, but only if it was retained expressly or by implication by the transferor in an inter vivos transfer. The terms "right" and "power" are to beT~E~rpreted broadly as under current law. Current law is also continued as to the capacity in which a power is exercisable and as to whether it is exer- cisable alone or only with the consent of another person. Section 21 encompasses a right subject to a discretionary power in another over whom the transferor has no control, but rights which are subject to a condition precedent immediately prior to the transferor's death other than the exercise of such a power are not so included. Thus, for example, the sect3.on will apply to a right in the transferor to receive income from a trust which he created as a member of a class of permissible recipients, even if the trustee has the dis- cretion to retain any or all income in the trust, but it will not apply in a case where the transferor's income interest follows a life estate in another whom he predeceases. Section 21 follows section 2038 in that the power must be in existence and exercisable until the transferor's death except that it applies to a right or power in existence at the transferor's death, limited by a fixed or ascertainable standard which is not met at the death. It also codifies the Lober case by specifically referring to the time of en- joyment of income or principal The general premise of the "hard-to-complete" rule in Section 21, which is more closely correlated with the income tax rules of sections 671 through 677 than the "easy-to-complete rule', is that inclusion is appropriate in an individual's -123- PAGENO="0207" 193 transfers at death where he has retained a right to current benefit from transferred property, or an existing or exer- cisable power to affect the enjoyment of the property. In either case, he has maintained a connection with, or a "string" over, the property which is not terminated until his death. In the case of a retained power, the final disposition of the transferred property is not fixed until the transferor's deat1~. Section 21 does not apply to a retained right to transferred property, its income or use, which is subject to a condition precedent other than the exercise of a power held by any person in any capacity. Thus, it does not apply to a reversionary interest in the transferor unless it has become possessory prior to the death. Such an interest nay be taxed under the other provisions of the Draft. If a transferor retains a right to receive such amounts of the trust income as the trustee in his discretion nay determine, Section 21 will apply because the transferor possess a right to benefit currently from the property, even though this right is subject to a discretionary power lodged in the trustee. On the other hand, if the transferor has no in- terest in the trust income until he attains age 50 and he dies prior to attaining that age, his right is not a current right to share in the property and Section 21 will not be ap- plicable. similarly, a retained power, such as a power to make payments to an individual who is unmarried only after he weds, confers no current control over the enjoyment upon the transferor and Section 21 will not be applicable. The amount includible under Section 21 is the full value at the transferor's death of the property which is the subject of his retained right or power. This result continues the more inclusive current rule of section 2036 rather than that of section 2038, and is appropriate because it is the full amount of such property in which the transferor has a right or over which he has a power. When, however, the transferor's retained power over a trust is preceded by an interest which is not subject to Section 21 the value of such interest will be taxed upon the creation of the trust because the transferor has not "retained" a power over such interest. To illustrate, if an individual places property in trust, retaining only a power of appointment over the remainder interest, he has no power to affect the income interests which precede the remainders. Accordingly, Section 21 will not he applicable with respect to the income interests, and these will be taxed at the time of the creation of the trust. -124- PAGENO="0208" Section 21 provides that, regardless of the terms of the governing instrument or applicable local law a right eligibility or power to which the section applies will be deemed to relate first to the income of the trans- ferred property This provision insures the inclusion in gross transfers of trust principal in an amount needed to produce income of the amount encompassed by the interest Examples (12) through (14) (pages 130-32) illustrate the scope and intent of this provision. Section 2037 is eliminated from the Draft It requires inclusion in the gross estate of transferred prop- erty if a beneficiary must survive the transferor to obtain possession or enjoyment and the transferor retained a re- version in the property worth more than 5% of its value The provision is unnecessary under the Draft since Section 21 as indicated deals broadly with retained rights Section 602 of H R 1040 (the Tax Equity Act of 1973) would broaden section 2037 by removing the 5% test This test was enacted in 1954 to overrule case law holding that even a technical reversion in the transferor could give rise to an estate tax upon his death Section 602 in effect would codify the rules under those cases and property would be included in the transferor s estate whenever his death results in a change in the possession or enjoyment of the property The proposal is defended on the ground that the 5% test is `completely a non sequitur in a statute which imposes an estate tax on a lifetime transfer of an interest which can be possessed or enjoyed only by surviving the transferor We disagree because this approach equates a fortuitous non- volitional and unpredictable event the transferor s death with an interest which confers a beneficial right or power on the transferor until his death. We believe the fact that the transferor remains a measuring life with respect to the transferred property is irrelevant and is not an appropriate taxable event - the latter should be a volitional act by which the transferor can enjoy or control an interest in the property, not on whether something which happens to him can affect such an interest. b ~~cial Rules for Certain Charitable Transfers As discussed in connection with the AET of Section 2 Section 21 incorporates two special rules to insulate cer- tain charitable dispositions from the AET by having the life- time transfer treated as completed when made By excluding 194 -125- PAGENO="0209" 195 the disposition from Section 21, a deduction under Section 13 is precluded and the transfer is treated as "complete" irnmedi- ately; the applicable charitable deduction will then be deter- mined under Section 14. The first special rule, contained in the exclusion- ary language in parenthesis of subsection (a) (ii) permits the grantor's retention of a power to designate the solely char- itable recipients of the transferred property, its income or its use. Retention of such a power would have no Section 1 consequences because inclusion in transfers at death would be offset by an equal charitable deduction under Section 31 (the amount included would also be disregarded for purposes of the allowable marital deduction under Section 32). Simi- larly, Section 21(b) excludes lifetime transfers to pooled income funds and charitable remainder trusts where the transferor is the sole measuring life for all mon-charitable interests in the transferred property. 2. Section 13 This section provides that the value of property which is transferred to other persons during an individual's lifetime may be deducted at the time of the transfer if the property would be included in his transfers at death under Section 21 upon his death immediately after the transfer. The reference to Section 21 assures that, except in the case of "springing" rights or powers, a lifetime transfer will be taxed only once, either when made or thereafter. If Section 13 is applicable and the characteristics of the transfer remain unchanged until the transferor's death, the property will be taxed at that time. If an event occurs by reason of which the deathtime provisions of the Draft would no longer be applicable to the transfer at the death, Section 9 requires that the property be taxed upon the occurrence of the event. Thus the deferral of tax under Section 13 will necessarily result in a later tax. 3. Section 9 This section provides that if, after a transfer for which a deduction under Section 13 was allowed, an event occurs by reason of which the transferred property would not be included in the individual's transfers at death immediately thereafter, he is deemed to transfer the property upon the oc- currence of that event, with the result that the property will then be included in his transfers and a tax will be imposed on the transfer. This provision is necessary because the deduction under Section 13 turns upon the treatment of the -126- 688720 76 14 PAGENO="0210" 196 inter vivos transfer at the individual's death immediately therea?E~F Later occurrences taking place prior to the transferor's death could affect how the transfer will actually be viewed upon the transferor's death, and, absent Section 9, by reason of such intervening events it would be possible for a transfer to escape taxation both when made and also at the transferor s death Section 9 is broadly drawn so as to encompass any inter vivos event through which the property would no longer ST~cI~ü~ in the individual s transfers at death, regardless of the cause of the occurrence or its source It is immaterial that the occurrence was beyond the transferor's control or was unforeseeable. For example, the expiration of a 10 year right to all the income from a trust, which is the sole right or power retained by the transferor, will trigger inclusion of the property in his transfers. Similarly, Section 9 will apply upon a distribution of any property, whether income or principal, to a person other than the transferor where the property prior to the distribution was subject to a right or power in the transferor which would have resulted in inclusion of the property in his transfers at death Section 9 will be applicable only if an event would terminate the application of all deathtime provisions Thus, if a transferor retains several rights or powers of different duration in the property to each of which Section 21 would be applicable upon his death, Section 9 will apply only to the termination of the interest which is last to expire. In addition, Section 9 will not apply if after the transfer but prior to such a termination, the transferor comes into possession of an interest which would result in inclusion of the property in his transfers at death under a provision other than Section 21 - Section 9 will be applicable only where the propert.y would otherwise pass from the trans- feror untaxed at his death. If property is taxed under this section and is later included in the individual's transfers at death under Section 21, the credit under Section 35 will be available to mitigate the effect of this second inclusion. 4. Examples (1) A transfers property in trust, with the income to be paid to him during his life and the principal to be distributed to his descendants upon his death A has immediately after the transfer a right to the income from the property; if he died at that time, Section 21 would require inclusion of the property in his transfers at death. Accordingly, the deduction under Section 13 is available, and a transfer tax will not be paid at the transfer. Upon -127- PAGENO="0211" 197 A's subsequent death, the property will be taxed. (2) Same facts as in (1), except that A is to receive the income of the trust for a period of 10 years from the transfer rather than for his life. As in (1), no tax is payable on the transfer when made, since Section 21 would be applicable to the property on A's death immediately after the transfer. On the expiration of A's 10-year income interest, however, Section 9 will apply because the property would not be includible in A's transfers at death thereafter. The amount includible under Section 9 will be the full value of the property on the day A's interest expires. (3) Same facts as in (1) , except that A's income interest is to follow a life income interest in A's mother M. Since A's right is subject to a condition precedent until the death of M, Section 21 would not be applicable if A were to die immediately after the transfer. Accordingly, no deduction will be allowed under Section 13 and the transfer will be taxed when made. If A survives M, upon his death Section 21 will require the inclusion of the property in A's transfers at death but a credit will be available under Section 35. (4) Same facts as in (1) , except that A retains an interest as a member of a class of permissible recipients of trust income or principal, with the trustee having the power to determine the amount of the payments and to accumulate income. The fact that A's receipt of income or principal is subject to the trustee's power is disregarded, and the results of the transfer are those described in (1) above. If the trustee exercises his discretionary power to pay income or principal to another, A makes a transfer at that time in the amount of such payment. The same result occurs when the trustee makes a payment mandated by the trust instrument to other persons upon the occurrence of a stated event. (5) A transfers property in trust, to pay the income to B for 10 years, at the end of which the trust will terminate and the property will revert to A or his estate. The value of B's 10 year income interest will be taxed immediately. Upon A's death within the 10 year period, Section 19 will apply to the value at date of death of A's reversionary interest. If A dies after the trust has terminated, he will hold the property outright and no credit under Section 35 will be available. -128- PAGENO="0212" 198 (6) A creates a trust, with income payable to persons other than himself for their lives, retaining the right to receive the principal if he survives the last to die of such other persons. Section 13 will not be applicable to the transfer when made, because A's retained right is subject to a condition precedent viz his surviving the income beneficiaries. Accordinglythe entire value of the property transferred in trust is immediately taxable. If A predeceases one or more of such other persons Section 21 will not be applicable, since A's right is subject immedia- tely prior to his death to a condition precedent. The prop- erty will. not be included in his transfers under Section 19 because A's contingent right does not survive his death. If A's death follows those of all such other persons, he will hold the property outright at his death. Since his contingent right to it will have matured, and it will no longer be held in trust, Section 21 will not be applicable, but the property will be taxed under other provisions of the Draft. The above results will also occur where ~ retains a right to receive the property which follows a defeasible vested remainder in another (7) A creates a trust of which he is neither a principal nor aii income beneficiary, giving a general power of appointment over the prOperty to a designated beneficiary. Section 13 will not be applicable at the transfer, because A has not retained a right in the property -- he is no more than a potential appointee with respect to the property Acccordingly the transfer is taxable in full when made The same will be true of a special power of appointment exercisable only by will where A is a permissible appointee If however, a special power of appointment where A is a permissible appointee is involved and it is presently exercisable, Section 13 would be applicable because the trust property remains taxable under Section 21 (8) A creates a trust with the income and prin- cipal in the discretion of the trustee, payable to B during B's life. A retains a power to change the beneficiary of the trust but cannot name himself as the beneficiary Sec- tion 13 will apply to the transfer when made because the retained power is described in Section 21 No tax will he immediately payable but the trust property will be included in A's transfers at death. Each payment of income or prin- cipal by the trustee to B will constitute a lifetime trans- fer by A -129- PAGENO="0213" 199 (9) Same facts as in (8), except that A may exercise his power only after a designated beneficiary dies, and A predeceases that beneficiary. Section 13 will not apply to the transfer when made, since A's retained power will not have come into existence immediately after the transfer. Accordingly, the transfer will be taxed in full when made. At A's death the property will not he includible in his transfers. If the beneficiary predeceased A, Section 21 would be applicable upon A's death, and the credit under Section 35 will be available. (10) Same facts as in (8) , except that A retains only a testamentary power of appointment. The results would be the same as in (8) because A's power is exercisable as to the entire trust property if he dies immediately after the transfer. (11) Same facts as in (8), except that A retains a power for his life to direct payments of trust principal, after a designated beneficiary reaches age 40, to that beneficiary in the event of his hospitalization. A dies after the beneficiary reaches 40 but prior to his being hospitalized. Section 13 will r~ot apply to the transfer when made, since A's retained power would not be in existence if he dies immediately after the transfer. When A dies, Section 21 will be applicable, because his power is then a present power. The fact that its exercise is limited by a fixed standard is disregarded. The credit under Section 35 will, however, be available. (12) A creates a trust, retaining a non- cumulative right exercisable annually to withdraw 10% of the principal. Section 13 will be applicable upon the creation of the trust because A's power is one described in Section 21. For purposes of Section 21, A's right will be deemed to relate first to trust income and to constitute in this case a right to withdraw all such income because the percentage withdrawal exceeds the assumed income yield of 6% prescribed by the Treasury tables for valuation of such an interest. Accordingly, Section 13 will provide a deferral of tax for the entire amount of the property A transferred into trust. If the percentage subject to withdrawal were 5%, A would be deemed to have made a taxable transfer of 1/6th of the trust property at the time the trust was created. A's failure in any year to exercise his right of withdrawal, or to withdraw the full amount allowable -130- PAGENO="0214" 200 thereunder, will constitute a transfer under Section 9 to the extent of the amounts not withdrawn reduced by the amount of the "loss" he may recapture through exercise of the right in later years the computation of which will be complex. This differs from the treatment accorded the holder of a 5 and 5 power under Section 22 relating to powers of appointment - where A is both the transferor and the powerholder, his status as transferor provides the appropriate and preferable focus for the imposition of the transfer tax. A's transfers at death will include as much of the trust principal as would be needed to produce income in the amount of the withdrawal. This result will follow whether or not the right is exercisable immediately prior to death because the right has been, in the words of Section 21, retained "until his [A's] death." Section 21 will apply even though the right may be exercised only if A is living on a particular day subsequent during the year. (13) A creates a trust, retaining a non-cumulative right exercisable annually to withdraw a fixed amount (say $10,000) of the principal. Thus, the amount subject to the right does not change from year to year as it does in (12) Section 13 will be applicable upon the creation of the trust because A s power is one described in Section 21 The amount subject to Section 21 may fluctuate as the assets of the trust increase or decrease in value. If, using the assumed yield of 6%, the projected income is less than $10,000, Section 21 will be applicable to the entire trust upon its creation. If the projected income is more than that figure, Section 21 will be applicable to only a part of the trust and thus the balance of the trust will be treated as a transfer by A upon the creation of the trust. A subsequent increase in the value of the trust determined as of the date of termination of the right of withdrawal for any year, will result in A making a taxable transfer if as of that date the projected income is less than $10 000 The amount of the transfer will be the entire $10 000 since A cannot recapture any part of the $10 000 in a later year This contrasts with the amount which is treated as a transfer under (12) where a fractional share right of withdrawal terminates for a particular year. Subsequent increases in value of the trust property will result in further transfers by A, the rule being that if the projected income is less than $10,000 such a transfer will take place for any year in which the value of the trust exceeded its highest value for any preceding year. -131- PAGENO="0215" 201 (14) Same as (12), except A's power to withdraw a percentage of the trust principal is cumulative The treatment of the initial transfer will be the same as in (12) The failure in any later year to make the permitted withdrawal will result in no transfer at that time, because the amount which could have been withdrawn remains available to A - a "kitty" accumulates consisting of these amounts which A did not withdraw at the first opportunity Upon A s death the kitty will be deemed a separate taxable amount included in A's transfers at death, viz., this amount will be ascertained and subtracted from the principal of the trust A s right to withdraw with res-pect to the remaining amount considered to he trust principal will then be valued as in (12) thus if his right were a right to withdraw 5% of trust principal, 5/6ths of the principal remaining after subtraction of the kitty would be includible in his transfers at death under Section 21 (15) A creates a trust retaining the power to change the trustee and to appoint himself The treatment of suoh a case depends on whether the trustee has any discretion with respect to determining the beneficiaries or the time at w?~ ch they may enjoy their interest in the property. If he doc~~, A's power will be included within Section 21, and the tiansfer will be taxed only upon A s death If he does not the transfer will be taxable when made Sections 10 15 27 and 32 Marital Deduction A Introduction Under the current gift ~nd estate tax laws a donor or a decedent is, if certain requirements are satisfied, permitted a deduction for the value of property trans ferred to his spouse. Section 2523 allows a gift tax deduction for one-half the value of such transferred property section 2056 allows an estate tax deduction not to exceed one-half of the decedent s adjusted gross estate, for property which passes to the surviving spouse These provisions were made a part of the gift and estate tax laws in 1948 in an attempt to equalize the tax results of transfers between spouses in common law states with those in community property states In order to obtain the marital deduction the property involved must be subject to the spouse s unrestricted power of disposition at a time no later than her death thus assuring that it will be taxed as a part of her estate at death unless given away or consumed during life. Accordingly, the -132- PAGENO="0216" 202 deduction permits a postponement but not an avoidance, of tax A technical rule referred to as the terminable interest rule must be satisfied for marital deduction qualification when the property does not pass outright to the spouse. The current marital deduction provisions have been criticized both qualitatively and quantitatively, and also as being unnecessarily complex. See, for example, the ALl Project at 31-32, 144-45, and the Studies at 356-60. The ALl Project and the Studies recommend liberalization of the current marital deduction provisions in terms of both quality and quantity. Stated simply, the recommendations are that no limit be placed on the amount of property which may be trans- ferred tax-free between spouses and that a life estate (or income interest), viz., a current beneficial interest in property, unaccomp~Ted by a power of disposition (appointment) in the spouse, qualify for the deduction. Also, an election would be provided to permit an immediate tax to be paid on all or a part of "qualifying" property, in which event no tax would be payable on such property at the surviving spouse's death. A corollary of the unlimited marital deduction is that the non-donor spouse could consent to having all or any part of a lifetime or deathtime transfer by his spouse being treated as her transfer for transfer tax purposes These reOommendations are appealing. They do, however, raise some questions. The questions relating to an unlimited marital deduction are twofold First a com- plete exemption from taxation for transfers to a spouse will encourage such transfers at the expense of transfers to other members of the transferor's family. Where the spouse will need all of the income to live on - as will usually be the case with the small and medium size estate - this result should not have an adverse effect. However, in the case of the larger estate, where the income is more than sufficient to satisfy the spouse's needs, the tax "pull" of avoiding all tax may lead to unwise dispositions ignoring other family members, at least until after the spouse's death. Second, and more important, when a part of the estate is more than sufficient to satisfy the spouse's needs, it may be argued with considerable force that there is no reason to postpone the collection of all tax. With regard to the current beneficial enjoyment test, the issue is "forcing" transfers upon the surviving spouse as a result of the termination of the current beneficial interest prior to death. In such a case, every subsequent transfer by the spouse of her or his own property will result in additional transfer tax because the "forced" -133- PAGENO="0217" 203 transfer caused by the termination of the current beneficial interest will be included in her or his computation base for determining the transfer tax on each such subsequent trans- fer. Both the ALl Project and the Studies recognize the forced transfer problem by providing that (i) the surviving spouse must elect to have an income interest qualify for the deduction, thus assuring that her consent is required for a forced transfer, and (ii) upon termination of the limited interest the tax would be paid out of the property subject to the interest at the highest rate of tax applicable to the spouse's transfers. These protections do not, however, completely solve the problem when the current beneficial interest terminates during the spouse's life. The spouse ` s election has a "forced" aspect to it since if she does not elect the tax will be increased and her income will be reduced. B. Qualitative and Quantitative Changes Made by Draft We believe the marital deduction reconunendations of the ALl Project and the Studies should be modified to allow an unlimited marital deduction only for transfers below a stated dollar amount and to permit a current beneficial interest to qualify for the deduction only if the interest could not be terminated during the surviving spouse's life without her or his consent. We have, however, encountered among our members a substantial amount of op- position to a shift to a current beneficial enjoyment test. The persons opposing this change believe that (1) it will be productive of considerable litigation even though it resembles the income requirement of a marital deduction trust under current law and (2) it will produce undesirable complexity because of the absence of control in the surviving spouse through a power of appointment and the fact that the same type of interest may both qualify and not qualify for the deduction. Thus, our support for a shift to the current beneficial interest test is somewhat hesitant. The most unfortunate aspect of the current marital deduction law is, in our judgment, the choice that it requires of the owner-spouse of a medium size estate of between $150,000 and $300,000. In many cases he would, absent tax considerations, leave his entire estate or substantially all thereof outright to his spouse. If his lawyer is well- informed, he will be advised that such a disposition will in all likelihood result in increased estate taxes because although one-half of his property qualifies for the marital -134- PAGENO="0218" 204 deduction all of the property (after the estate taxes on the other one-half) will be taxed in his spouse's estate, subject to a previously taxed property credit in a reducing amount if the spouse dies within 10 years of her husband's death. In order to avoid this `double" tax on approximately one-half of his estate, the husband must create a trust or legal life estate of the non-marital portion so as to limit his spouse s interest or interests therein to non-taxable interests. Despite the fact that this situation is good for our trust business, the husband should not be put to this choice The marital deduction should be modified so as to permit what will amount to an unlimited deduction for the medium size estate. The small estate already has an "unlimited' marital deduction as a result of the combined effect of the $60,000 exemption and the marital deduction. Of course, the medium size estate owner may not desire to take advantage of such a change because it will not permit the use of the separate rate structures (husband and wife) to minimize the combined estate taxes on both estates. Sections 15 and 32 increase the available marital deduction.to the greater of $250,000 or one-half of the "adjusted transfers", a defined term. Section 34 allows a credit against the transfer tax payable at death, which has the effect of granting an additional exemption of between $70,000 and $100,000. Thus, no tra~isfer tax may be payable on a net estate of as much as $350,000 left to a surviving spouse. Also, in computing the $250,000 limitation, certain property that receives preferred income tax treatment (distributions from qualified pension and profit sharing plans or from H.R. 10 plans or group-term life insurance not in excess of $50,000) is to be ignored, viz, will qualify for the deduction to an unlimited extent and will not affect the qualification of any other property If any further relief should be deemed advisable, we would favor permitting the surviving spouse to claim any part of the credit of her spouse under Section 34 which is not needed as a result of the marital deduction alone being sufficient to eliminate tax. During 1970 133,944 federal estate tax returns were filed. Only 13% of these returns were for gross estates in excess of $300,000. Thus, the $250,000 marital figure plus an exemption of between $70,000 and $100,000 would amount to a potential unlimited marital deduction for more than 87% of the estates filing returns in 1970. Using these same returns, this compares with a figure of 58% for gross estates of $120,000 or less for which a potential unlimited -135- PAGENO="0219" 205 marital deduction would be available under current law as a result of a marital deduction for one-half of the adjusted gross estate plus the $60,000 exemption.* C. Revenue Effect of Changes A shift to a marital deduction of at least a stated dollar amount will result in a permanent loss of revenue when compared with current law because the `double" tax that now exists as a result of overqualifying outright transfers will be eliminated for the medium size estate. The ALl Project (pages 411-12) indicates that if there were an unlimited marital deduction the permanent loss from the elimination of the double tax would be 7% of current gift and estate tax revenues. It seems reasonable to assume that most of this loss would remain under the qualified unlimited marital deduction approach of the Draft. D. General Explanation of Sections In Sections 15 and 32 a general rule of deductibility is stated for outright transfers to a spouse and for transfers in which the spouse receives a current beneficial interest. It is followed by a special rule for transfers of property previously held by the transferor and his spouse as community property. The limitation on the amount of the deduction is then dealt with separately, and a "fall-back" provision is included to continue current law as to the amount of the deduction if available records are inadequate to justify a deduction within the general limita- tion. Special provisions are included in Section 32 to assure that a deduction will be available where distribution is delayed or property is received pursuant to the exercise of elective rights. These problems do not arise in connection with transfers during life. Section 27 requires inclusion in the spouse's estate of all property for which a marital deduction is allowed under the current beneficial interest rule. Section 10 produces the same result for a lifetime transfer when the spouse voluntarily disposes of the current beneficial interest by assignment or otherwise during life. Section 44(a) (1) directs payment of the transfer tax from'the affected property at the spouse's highest rate or rates * The data in this paragraph is taken from Statistics of Income -. 1969, Estate Tax Returns, Internal Revenue Service Publicati~i~ 764 (7-72). -136- PAGENO="0220" 206 of tax upon the termination of the current beneficial interest by death Sections 15 and 32 use the term "current beneficial interest", which is defined as a current right not subject to termination other than by the death of the recipient spouse. "Adjusted transfers" is defined separately for inter vivos and deathtime transfers in order to reflect the differences between such transfers in terms of the 50% limitation. The liberalization of the amount that may qualify for the marital deduction requires a change in current law when community property is involved If the other spouse s share of community property continues to be deducted before applying the $250 000 fixed dollar limitation estates consisting of community property would have an advantage. For example, in an estate of $400,000 consisting entirely of community property only $200 000 would be included in the taxable transfers and the $250,000 amount would eliminate any tax On the other hand a $400 000 estate with no community property would incur a tax on $150,000 ($400,000 - $250,000) before the credit under Section 34 is considered This result is avoided by providing an "add-back" for the other spouse s share of community property The limitations are then applied to this total figure. Thus, in the example given above, to arrive at the allowable marital deduction for the community estate of $400,000, the $400,000 figure will be included in the decedent's transfers, and the maximum deduction will be the same as for an estate of $400,000 having no community property. For inter vivos transfers, the add-back is applicable onlyiYthe property transferred is community property. For transfers at death, the add-back encompasses the surviving spouse's entire interest in community property. E Detailed Explanation of Sections 1 Sections 15 and 32 a Property Available for Deduction - subsections (a) (1) (A) , (b) (1) and (b) (2) Subsection (a) (1) (A) sets forth the general rule that a deduction is allowed in an amount equal to the value of property which passes outright to the transferor's spouse or in which such spouse possesses a current beneficial interest. The allowable amount is, however, limited by -137- PAGENO="0221" 207 paragraph (2) of subsection (a). Thus, after it is determined that a transfer of property qualifies for the deduction, reference must be made to that paragraph to ascertain the actual amount allowable. The term passes that is used in current law is retained. Section 2056(e) contains an elaborate definition of when an interest in property is deemed to "pass" to another person. It has been omitted as unnecessary. The matter may be covered by regulation. Sections 15 and 32 do not contain an all encompass- ing definition of an "outright transfer" of property. The nature of the property or the interest transferred is irrele- vant in determining whether the transfer is "outright". Thus, for example, a transfer to the spouse of an indefeasibly vested trust remainder interest is an outright transfer even though the interest is not a present interest. Subsection (b) (2) of each section does, however, contain an "inclusion" provision for two situations that are to be treated as outright transfers. The first relates to an estate" trust and continues current law permitting such a trust to qualify for the marital deduction. See Revenue Ruling 68-554, 1968-2 Cum. Bull. 412. To be deemed an outright transfer, the transferred property must be held in a separate fund and the spouse and her estate must hold all beneficial interests in the property other than those derived from her exercise of a general power of appointment over the property. Thus, this pro- vision settles the question under current law whether an `estate' trust under the terms of which a general power of appointment precedes the interest of the spouse's estate may qualify for the marital deduction in favor of allowing a marital deduction for such a trust. See Revenue Ruling 72-154, IRB 1972-14 at 14. An annuity is specifically excluded from the coverage of this provision. Subsection (b) (2) (ii) of Section 32 establishes a second special rule which treats as an outright transfer, and as qualifying for the marital deduction, all widows' allowances which are actually paid prior to the filing of the transfer tax return. This changes current law, see Jackson v. United States, 376 U.S. 503 (1964), but parallels the rule proposed by the ALl Project (page 143). Subsection (b) (1) defines a current beneficial interest as a right for life, commencing as of the date of transfer, to the income from or the use of property. This is, in effect, the "income" requirement of section 2056(b) (5) and, subject to one qualification, is to -138- PAGENO="0222" 208 be interpreted consistently with the current regulations re- lating to this requirement. The qualification is that accrued or collected but undistributed income need not be distributed to the spouse's estate or be subject to a general power of appoint- ment exercisable by the spouse. The accruals will, however, be treated as a transfer at death by the spouse under Section 27. For the reasons discussed above, a current bene- ficial interest must be one whose duration may be terminated only as a result of the death of, or an assignment by, the spouse. Thus, a term for years will not qualify, since it is otherwise terminable. The word "right' makes it clear that the spouse must receive an interest in the property which is definite and certain and not subject to a discre- tionary power in any other person. A power to pay principal to a person other than the spouse will prevent the spouse from having a current beneficial interest. A current beneficial interest must commence as of the date of transfer. An intervening interest in another which delays the commencement of the spouse's interest precludes a marital deduction for the transfer to the spouse. For example, if the spouse receives a life estate in property which is to follow a 10-year interest in another, no deduction will be available. Special rules with respect to transfers at death are provided for delayed distributions and interests acquired pursuant to the exercise of elective rights. Sections 15 and 32 permit an annuity - a right to receive a fixed amount per year - to be treated as a current beneficial interest, and thus qualify for the marital deduction, whether or not a segregated fund exists for its payment and whether or not a person other than the spouse is also entitled to receive an amount under the annuity "contract." Subsection (b) (1) (B) (ii) accomplishes this result by providing that the right to receive a fixed amount per year shall be considered a right to the income from property or from a specific portion of property. This treatment of annuities under Sections 15 and 32 differs in three respects from that accorded annuities under the current marital deduction regulations. First, Treas. Reg. §S20.2056(b)-5(C) and 25. 2523(e)-l(~T~fifle a "specific portion" as a fractional or per- centile share. The Supreme Court has rejected this interpretation, as has the Second Circuit Court of Appeals. See Northeastern Nat. Bank v. United States, 387 U.S. 213 (1967), arid~Gelbv. Commissioner, 298 F.2d 544 (2nd Cir. 1962). The Draft does Iikiviise. As the Second Circuit Court of Appeals noted in -139- PAGENO="0223" 209 `~e1b actuarial computations may be employed to determine what specific portion supports the right to the fixed payments. If a segregated fund has been created from which the annuity is to be paid, this portion of the fund will be taxed under Section 10 or 27 upon the termination of the spouse s interest The presence in the dispositive scheme of a discretionary power in a trustee or another to distribute principal to the spouse will be disregarded in determining the specific portion to which her interest in the fixed dollar payment relates If no segregated fund is established and the transferor has created property rights in persons other than his spouse to follow the spouse s death all or a part of the value of these rights will be includible in the spouse's transfers at death on the basis that this value "supported" the annuity payments made to the spouse. To illustrate, if pursuant to a deferred compensation con- tract, the value of which was includible in his `transfers at death the decedent s spouse was entitled to receive $5 000 annually for her life and his daughter was to receive $2 500 annually for life after her mother s death the discounted actuarial value of these combined payments would be their value as finally determined in the transfer tax proceeding An imputed return will then be determined by multiplying the transfer tax value by the rate of return prescribed in the Treasury tables applicable at the dece- dent's death. If the spouse's annual annuity payment equals or exceeds the imputed return, the spouse will be deemed entitled to the entire income under the contract and upon her death the actuarial value at the time of the payments to the daughter will be treated as a transfer at death by the spouse. If the spouse's annual payment is less than the imputed return, the spouse will be deemed entitled to all the income from that percentage of the actuarial value of the daughter's rights which is'derived by dividing the spouse's annual payment by the imputed return. The method of determining the amount taxable in the spouse s transfers is necessarily imprecise but not unreasonable The discounted value of payments to be made after the spouse s death has no relation to the amount needed to fund the payments actually made to the spouse during her lifetime In addition use of a discounted value in computing the imputed return results in a smaller figure for the return than if a full value amount were employed since the spouse s annual payment is a full value amount the comparison of the imputed return with the actual annual payment to be received will overstate -140- PAGENO="0224" 210 the marital deduction and the amount to be taxed in the spouse s transfers at death in every case Furthermore it requires use of the rate prescribed in the Treasury tables which at the current level of 6% is unrealistically high and unrelated to the actual performance of trusts Nevertheless, this approach appears to be the best approach taking into consideration both fairness and simplicity It is generally speaking the same method suggested in the Treasury Studies (pages 378-79). Second, the Draft permits a marital deduction for an annuity providing for a refund or further payments after the spouse's death. Under Treas. Reg. SS20.2056(b)-l(b), 1(c) and 1(g) Example 3 and 25 2523(b)-l(a) (3) 1(b) (1) and 1(b) (6) Example (iii), such an annuity presently constitutes a terminable interest which is nondeductible because a person other than the surviving spouse also obtains an interest in the property which may result in his possession or enjoying the property after the spouse s interest terminates or fails A change is required because of the shift to the current beneficial interest' theory. Third Treas Regs §20 2056(b)-l(f) provides that no marital deduction is allowed for an annuity or a terminable interest which the decedent directs his executor or a trustee to acquire after his death. The rule is otherwise if the annuity is purchased during the decedent's life. Treas. Reg. §20.2056(b)-l(g) Example (3). There is no sound basis for this distinction. It is eliminated under Sections 15 and 32, and an annuity will qualify for the marital deduction even if acquired pursuant to the decedent's direction after his death. Such an annuity will be treated exactly as any other annuity under the Draft: if it contains no refund feature there will be no property to be taxed upon the surviving spouse s death if payments are receivable by another after her death, their value will be taxed as described in the preceding paragraphs. It may be argued that the treatment of annuities described above results in the creation .of a new tax "loophole" - a marital deduction will be allowable for the value of amounts to be received in the spouse's lifetime which, by reason of the consumption of the supporting fund before the spouse's death, may.. not be taxed in her transfers Thus an avoidance of all transfer tax on these amounts may result under the Draft rather than the deferral provided by current law. One answer to such an argument is that this result is possible today. If a testator desires his spouse to receive the entire income generated by his estate, he can create a marital deduction trust and provide that the entire income therefrom is to be paid to -141- PAGENO="0225" 211 his spouse as well as an amount from trust principal equal to the income generated by a second, non-marital deduction, trust containing the other assets of his estate His spouse can also be named as a member of the class of beneficiaries of this second.trust. In this way, the marital deduction trust which was not taxed on creation may be fully depleted prior to the spouse's death, and thus escapes all transfer taxation. ,A second reply to the "loophole" argument is that the amount received under an annuity and consumed by the spouse leaves intact an equivalent amount of the other assets available to the spouse which will be taxed in her transfers upon her death. In order to obtain a charitable deduction for the transfer of a remainder interest to a charity a unitrust annuity trust or pooled income fund format must be used A unitrust or annuity trust would not in all events make payments to the income beneficiary of its entire net income or all income from a specific portion. Thus, without a special provision, a transfer to such a charitable remainder trust could not qualify for a marital deduction. There is no policy reason supporting this result. Accordingly, where the spouse is the sole non-charitable recipient subsection (b) (1) (B) (i) permits a marital deduction for any of the allowable unitrust or annuity trust formats, by tre~.ting her interest as a right to all the income from property Consideration was given to qualifying a part of such a trust where the spouse was one of several non-charitable recipients but this approach was rejected on the ground of unacceptable complexity If a marital deduction is available Sections 14 and 31 specifically prohibit the allowance of a charitable deduction for the value of the remainder interest in the same property. b. Property Formerly Held as Community Property - subsection (a) (1) (B). Under current law, community property is excluded from marital deduction computations An inter vivos division of community property between spouses subject to gift tax since the spouses have equal ownership rights in the property Similarly upon the death of a spouse when the interest in community property becomes possessory in most jurisdictions the decedent is treated as owning only one-half of the community property for estate tax purposes A conversion of community property into separate property results in an equal division of the property If thereafter a marital deduction was allowed for the spouse s share of the former community property a tax-free transfer of 75% of a former community to the -142- 688720 76 15 PAGENO="0226" 212 recipient spouse would be possible. Sections 2056 (c) (2) (B) and (C) and 2523(f) preclude such a result by requiring a subtraction of the value of any former community property in arriving at the adjusted gross estate or gifts to the donor's spouse, against which the present 50% limitation is applied. These provisions are continued in subsection (a) (1) (B) of Sections 15 and 32, with a modification necessary becauseof the fixed dollar marital deduction provisions of the Draft. Subsection (a) (1) (B) provides that where property held as community property has been converted into separate property, a narital deduction is permitted with respect to a subsequent transfer of that separate property only to the extent that the transferred property does not exceed the figure calculated under the formula set out in this sub- section. The subsection does not authorize a deduction based on a percentage of amounts transferred, thus continuing current law to that extent. It does, however, permit a deduction based on a fixed dollar amount and thus makes the situation of a taxpayer transferring property formerly held in community equal to that of a taxpayer who never held community property. For example, assume a taxpayer in a community property state, who had converted $300,000 of community property into equal shares held separately by his spouse and himself, makes a gift of his separate share, $150,000, to his spouse. Because the property was formerly held as community property, he is not entitled to a marital deduction based on a percentage of his transfers. Absent subsection (a) (1) (B), he would also not be entitled to any deduction based on his transfer of an amount less than a fixed dollar maximum, unlike a similarly situated taxpayer in a common law state. The formula of the subsection confers the benefit of the fixed dollar maximum on an individual transferring former community property, and adjusts the maximum dollar amount allowable to take into account the special status of such property. The starting point under the formula is the amount of the separate property of the spouse previously transferred fOr which a deduction was allowed. To arrive at the equivalent amount where converted property has been previously transferred, the amount deducted by reason of such prior transfers must be doubled. These two amounts are then aggregated and represent the equivalent of the amount of the $250,000 fixed marital deduction maximum already used by the taxpayer Accordingly this amount is subtracted from the $250 000 to establish the remaining portion of the fixed dollar limitation available and again because of the special characteristics of converted -143- PAGENO="0227" 213 property, this amount must be halved to arrive at the actual amount deductible. c. Limitations - subsections (a)(2) and (b) (3). Subsection (a) (2) places a limitation on the amount of the available marital deduction. Subdivision (A) prescribes the general rule which presupposes the existence of adequate records of prior transfers. These are particularly important where.. a deduction is claimed pursuant to the fixed dollar limitation. Under the general rule, the percentage limitation is based upon all of the conveying spouse's adjusted transfers, as ~I~ined in subsection (b) (2) including prior transfers If, adequate records are not available, sub- section (2) (B) becomes applicable and the allowable marital deduction is restricted. In the case of a transfer by a taxpayer living in a common law state it will be limited to 50 percent of his transfers in the current calendar quarter or his transfers at death, whichever is applicable. This provision contains the same 50 percent limitation that exists under the current gift and estate tax marital deduction except that in the case of a lifetime transfer it permits the limitation to be applied against all transfers during the calendar quarter rather than merely against those to the spouse otherwise qualifying for the deduction. In the case of a transfer of property which was converted after the effective date of the Draft from community property into separate property, no marital deduction will be allowed --` this result is necessary because the "fall-back" deduction of subsection (a) (2) (B) is premised on the application of a percentage and no deduction based on a percentage limitation is allowable in any event with respect to a transfer of such former community property. In the case of employment benefits which currently receive preferential treatment under section 2039 (c), and amounts payable under a "Keogh (H. R. 10) Plan' or as proceeds of group-term life insurance for which the special treatment of section 79(a) is available, no limitation is placed on the amounts deductible and they are disregarded in the calculations of the limitations relating to other property. Thus, as discussed in more detail below, these benefits may pass without immediate transfer tax to the spouse and they do not affect the deductible amounts of other property qualifying for the marital deduction. -144- PAGENO="0228" 214 (1) Subsection (a) (2) (A) Under this provision the marital deduction is limited to the greater of $250,000 or one-half of the individual s adjusted transfers , as defined in sum- section (b) (2). This definition is different for life- time transfers than it is for transfers at death. The. adjusted transfers of an individual are relevant only with respect to the percentage limitation of subsection (a) (2) (A) - where that subsection is applicable the maximum marital deduction is limited to one-half of the adjusted transfers. The basic function of the term under a single transfer tax rate structure, and as defined in subsection (b) (3), is to provide an aggregation of an individual's total transfers, including prior transfers. Although similar adjustments are required under subsection (a) (2) (B) (relating to the maximum deduction where available records are inadequate), only current transfers of the individual are considered there. For inter vivos transfers, subsection (b)(3) of Section 15 ~6~ides that the adjusted transfers shall be the total value of the individual's transfers from the effective date of the Draft through the current quarter, reduced by the aggregate amount of any per-donee annual exclusions applicable to those transfers and of charitable deductions allowed the transferor for trans- ferred property included therein. Thus, the percentage limitation will operate along the lines of the current estate tax marital deduction, rather than the current gift tax marital deduction pursuant to which only one-half of the property transferred to one's spouse may be deducted. The deduction is available for property transferred to the individual's spouse, up to a maximum of one-half of his adjusted transfers, rather than merely one-half of the transfers to the spouse that meet the statutory requirements other than the percentage limitation. For example, assume a transfer,of $500,000 to a stranger and a contemporaneous transfer of $300,000 to the transferor's spouse. Adjusted transfers will be $800,000. The marital deduction will be the full amount of the property transferred to the spouse because this amount is less than one-half of the adjusted transfers ($400,000). If the transferor thereafter transfers an additional $700,000 to his spouse, the spouse will have received a total of $1,000,000 but the marital deduction will be limited to $750,000 ($1,500,000 + 2) -145- PAGENO="0229" 215 For death-time transfers subsection (b) (3) of Section 32 provides that adjusted transfers consist of the total of the individual s inter vivos transfers with adjustments (the adjusted tr~iIT~rs computed under Section 15(b) (2)), plus the transfers at death reduced by the deductions allowable under the successors to present sections 2053 and 2054 (expenses and losses) In the case of both lifetime transfers and transfers at death the adjusted transfers for prior periods are reduced by the amounts allowed as charitable deductions in order, generally, to restrict the base upon which the percentage limitation is calculated to transfers which were taxed. Without such a reduction charitable transfers in previous periods could be used to shelter from tax the subsequent transfer of a substantial amount of property to the spouse. Subsection (b) (3) (ii) modifies the current definition of "adjusted gross estate" of section 2056(c) (2) (A), by requiring reduction for allowable expenditures and losses under Sections 29 and 30 rather than for allowed amounts This change eliminates the pull for an executor under a will containing a formula marital deduction provision - a provision keyed to the maximum marital deduction - to claim expenses and losses on the fiduciary income tax return rather than on the estate tax return where the availability of a marital deduction for one-half of the amount by which the adjusted gross estate is thereby increased results in a smaller overall current tax burden. It also responds to the argument, made in the Studies (at 382-84) in connection with the election to take certain allowable expenditures on the income tax or estate tax return, that the executor faces a conflict of interest by reason of the election (see discussion of Section 29) -- the maximum marital deduction will remain constant regardless of how the executor chooses to claim the amounts allowable under Sections 29 and 30. The operation o~f subsection (a) (2) (A) may be illustrated as follows assume an individual with no prior transfers makes a lifetime transfer of $150 000 to `xis spouse Ignoring the annual exclusion his adjusted transfers will be $150 000 Applying the limitation of subdivision (a) he will be entitled to claim the full $150 000 transferred as a marital deduction - that amount does not exceed $250,000, and is greater than one-half of his adjusted transfers ($150,000 2, or $75,000). If the individual in a later calendar quarter transfers an additional $200 000 to his spouse for purposes of the limitation his adjusted transfers will be $350 000 and one-half of such transfers will equal $175 000 His -146- PAGENO="0230" 216 current deduction under this alternative would be $25,000 ($175,000 less the $150,000 previously deducted). On the other hand, if the fixed dollar limitation is used, $100,000 may be currently deducted ($250,000, now fully applicable since his transfers exceed that amount, less the $150,000 previously deducted). Since the fixed dollar limitation produces the greater amount, it will govern the allowable deduction in this instance. Upon the later transfer of an additional $50,000 to the spouse, no deduction will be allowed. The fixed dollar limitation has been fully consumed by reason of prior transfers, but that amount ($250,000) is in excess of one-half of the individual's adjusted transfers ($400,000 2, or $200,000). Where the adjusted transfers exceed $500,000, the allowable deduction will be based upon the percentage limitation; below that figure, the fixed dollar limitation will produce the larger deduction. (2) Subsection (a) (2) (3) As indicated previously, this subsection applies where available records are inadequate to supply the informa- tion on prior transfers needed to calculate the marital deduction allowable for a current transfer under the limita- tions of subsection (a) (2) (A). In common law states both the amount of an individual's prior transfers to his spouse and also the total o.f his adjusted transfers must be known. Where an individual makes a transfer of property which was converted to separate property from community property, since no deduction is permitted by way of the percentage limitations, only the amounts previously allowed as deductions under the marital deduction provisions are needed. Subsection (a) (2) (B) provides separately for each of these situations. Subsection (a) (2) (B) (i) provides different rules for interspousal transfers during life and at death. Both rules relate only to the transfers then being taxed -- with respect to lifetime transfers, those of the current calendar quarter are considered, while with respect to transfers at death, inter vivos provisions are disregarded. In each situation~ m~Ti~im marital deduction is limited to 50 per cent of the value of such transfers. Where an inter vivos transfer is involved, the percentage limitaEi i~~lied against the transfers during the current calendar quarter reduced by any exclusions provided in Section 11 (the annual per-donee exclusion) but not reduced by any amount allowed as a specific exemption under Section 12. Where a transfer at death is involved, the percentage limitation is applied -147- PAGENO="0231" 217 against the decedent's total transfers at death reduced, as under current law by the amounts allowable as deductions for expenses and losses (sections 2053 and 2054,' Draft Sections 29 and 30) Subsection (a) (2) (B) (ii) involv- ing a transfer of converted community property operates on a different basis from subsection (a) (2) (B) (i) If an individual's previous deductions under Section 15'cannot be ascertained, it is impossible to compute any relevant limitation with respect to a current transfer of such property In such a case subsection (a) (2) (B) (ii) provides that no deduction will be allowable. Because this pro- vision imposes a serious record-keeping burden upon taxpayers in community property states, which these individuals do not currently have subsection (a) (1) (B) has been changed to make it applicable only to transfers of former community property converted after the effective date of the Draft. This change may give rise to a "windfall" to a few taxpayers who converted community property after December 31, 1941 and before such effective date but it will greatly simplify the administration of the law in community property states and can be justified on the grounds that the assets will be taxed at the death of the surviving spouse. In any event, the choice of the appropriate date for subsection (a) (1) (B) is expected to affect relatively few taxpayers. It is anticipated that the Internal Revenue Service will preserve each individual's transfer tax returns, or the information set forth on these returns, for the period of his life. These returns or information will be needed properly to check the computation of the Section 1 tax on subsequent transfers during life or at death. Retention of the returns by the Service would virtually eliminate the cases to which subsection (a) (2) (B) would apply. It is also anticipated that the information on the returns with respect to a particular taxpayer will be made available to him by the Service in cases where his own records are inadequate or are not available. d Exclusion for Emplçyment Benefits - Subsection (a) (2) (C) of Section 32 This subsection provides for the receipt free from transfer tax by a surviving spouse of certain kinds of employment benefits. Under section 2039, benefits payable under qualified plans are taxed in the gross estate only to the extent of the amounts thereof which are attributable to the decedent's contributions as an employee - the remaining amounts are not includible in the gross estate and pass to the beneficiaries untaxed. -148- PAGENO="0232" 218 Since these amounts are not in the gross estate, they do not affect the marital deduction available for the decedent's included property passing to his spouse. The Draft, as discussed more fully in relation to Sections 23 and 26 dealing with employment benefits and life insurance, respectively, requires such benefits to be fully included in an individual's transfers at death. Nevertheless, in view of the positive policy positions taken by Congress in the income tax law encouraging certain forms of employment benefits, it is believed appropriate to provide a limited encouragement in the transfer tax area by means of an enlarged marital deduction. Accordingly, under this subsection, employment benefits which take one of the prescribed forms and otherwise qualify for the marital deduction are disregarded in computing the limitations under subsections (a) (2) (A) and (a) (2) (B) on the maximum allowable marital deduction. By reason of their inclusion in the decedent's transfers at death, the adjusted transfers (against which the percentage limitation is applied) will be increased but the amount of such benefits will pass outside of and will not count toward the applicable limitation. The spouse will thus receive the benefits of these amounts, undiminished by taxes, for her lifetime; at the same time, unlike current law, only a deferral of transfer tax rather than an avoidance of the tax is involved. Subsection (a) (2) (C) provides that, in computing the applicable limitation for the marital deduction under paragraph (2), the fact that a deduction is allowable for property included in the decedent's transfers at death under Section 23 or 26 is to be disregarded in specified instances. These are with respect ~to Section 23 amounts constituting employment benefits, as defined in that section, receivable by the surviving spouse under, generally, (1) an employees' trust.forming part of a plan meeting the require- ments of section 401(a); (2) a retirement annuity contract purchased by the employer, pursuant to a plan described in section 403(a); (3) a retirement annuity contract purchased by a religious or an exempt organization (4) provisions relating to armed forces personnel and (5) a Keogh Plan set up with reference to the requirements of P.L.fi-7~-792 for the encouragement of self-employed persons'.~tirement plans. The benefits receivable under the first four categories are those presently given favorable estate tax treatment under section 2039(c). Unlike the current law, the full amount of such benefits, regardless of the contributions -149- PAGENO="0233" 219 of the decedent and his employer thereto, will pass to the spouse without an immediate transfer tax The last category, the payments under a Keogh (K R 10) Plan recognizes the specific congressional intent to foster this type of retirement program by way of special incone tax concessions for the self-employed. With reference to Section 26, the proceeds of group-term life insurance are eligible for the special treatment of this subsection (a) (2) (C) to the extent of $50,000. This figure represents the amount of such insurance which the premiums entitled to special income tax treatment under section 79(a) could purchase. Thus, to the extent that the premiums allocable to the $50,000 in proceeds are not treated as income taxable to the employee when the premiums are paid that amount in proceeds may pass to the employee s widow without being subject to the limitation on the allowable marital deduction If both this division of subsection (a) (2) (c) and division (i) thereof discussed above are applicable to the proceeds of group-term life insurance the latter provision will govern, and the full amount of the proceeds will be insulated from an immediate tax. e. Election - subsection (c). Subsection (c) of Sections 15 and 32 permits a transferor to elect to incur an immediate tax upon a transfer which qualifies for a marital deduction Specifically the subsection allows a transferor to treat the transfer in whole or in part as one to which subsection (a) is not appli- cable. Subsection(a) is a mandatory provision so that, absent subsection (c), a transferor would be forced to take a marital deduction whenever subsection (a) applies A deduction might not be desired where for example each spouse has an equal amount of property prior to the transfer and therefore, the deduction would increase the total transfer tax burden of the spouses Subsection (c) permits an election only by the transferor The issue of whether the transferee-spouse should also be permitted to make the election assumes importance only in connection with transfers at death We believe it is inappropriate to permit the transferee- spouse to retain the current beneficial interest while forcing the transfer tax on the affected property upon the transferor s estate since this result may significantly distort the transferor s estate plan by reducing the prop- erty available for other beneficiaries of the estate This issue is of course different from whether the transferee- -150- PAGENO="0234" 220 spouse may disclaim the transfer. The transfer tax conse- quences of a disclaimer axe covered by Section 16 The election is intended to be a personal right of the transferor exercisable at the time of the transfer or by will if the transfer is at death the executor or administrator of his estate would not, therefore, be empowered to make the election for him. f Special Provision Applicable to Transfers at Death (1) t~ffect of Delay in Distribution - Section 32(a)(3) Subsection (a) (3) of Section 32 provides that an interest in property otherwise qualified will be eligible for the marital deduction despite the fact that the surviving spouse will not receive the property, or the income or annuity from or the use of the property until it is distributed by an exedutor or trustee, unless the executor or trustee is authorized or directed by the specific terms of the governing instrument to delay such distribution beyond the period reasonably required for the administration of the estate. This provision is derived from the current regulations, Treas. Regs. S20.2056(b)-5(f) (9), and makes it clear that the marital deduction will not be lost, if otherwise available, merely because the affected property is not distributable immediately so long as the governing instrument does not authorize or direct an unreasonable delay in dis- tribution It broadens the regulation s language to encompass a distribution from a trust as well as one from an estate. Section 32(a) (3) is particularly important in connection with the current beneficial interest requirement when applicable state law provides that no interest or income is payable on the affected property. See, ~ Wash. Rev. Code §11.12.220. The stated rule does not permit transfer tax avoidance because even though the surviving spouse is not entitled to interest or income until the marital trust is funded she will be deemed to have a current beneficial interest in the underlying property in applying Section 27. (2) Exercise of Elective Rights - Section 32(a) (4) Subsection (a) (4) states that a surviving spous&s exercise of elective rights available under applicable state law with respect to property in the decedent s transfers at death shall be deemed to have occurred as of the date of the decedent's death for purposes of the marital deduction. -151- PAGENO="0235" 221 it encompasses dower or cuyte~y interests and rights in lieu of these interests and any other analogous rights under applicable state law and codifies §20.2056(e)-2(c) of the current regulations. The effect of this provision is to treat the exercise of such a right as being effective as of the decedent's death so that property or an interest in property received pursuant to such exercise will not be rendered ineligible for the marital deduction if otherwise qualified, solely because the interest does not arise at the moment of death. This is the result under applicable state law. 2. Section 27 This section provides that an individual's transfers at death shall include the value of all property for which a deduction was allowed pursuant to Section 15 or 32 by reason of a transfer to such individual of a current beneficial interest in the property This special provision is required because a current beneficial interest is not in- cludible in the transferee-spouse's transfers under any other provision of the Draft. It does not, however, apply when the affected property is otherwise includible in gross transfers at death under any other provision of the Draft. Thus, for example, if the current beneficial interest was coupled with a general testamentary power of appointment in the surviving spouse, Section 22 would apply to the trust property upon such spouse's death and Section 27 would not, therefore, be applicable. Section 27 only applies to property passing to beneficiaries Thus if the current beneficial interest was a non-refundable annuity issued by a company engaged in the business of issuing annuities nothing would be taxable under this section because/no property passes. Where, however, a marital deduction has been allowed by reason of Section 15(b) (1) (B) (ii) or 32(b) (1) (B) (ii) for the right to receive a fixed amount annually,it is necessary to specify a rule for deternining the amount to be included in the spouse's transfers under Section 27. In these cases, all or part of the property underlying the right to payments will be included The second sentence of this section parallels the proposal of the Studies (page 378) that the ratio of the fixed payment to a projected return be applied to the total value of the fund set aside for the payments to compute the amount includible in the surviving spouse' s transfers. The Studies propose a putative annual income of 5% of the value of the fund the Draft instead employs the rate prescribed in the Treasury tables for valuing life estates, remainders and the like -- since that rate (currently 6%) is used as the pro3ected rate of return in thos instances it is the appro- -152- PAGENO="0236" 222 priate point of reference here as well. While the value of the fund will fluctuate, the ratio will be fixed on the basis of the values as the original transfer. For example, if an individual establishes a trust of $100,000 which provides that his spouse receive $2,000 per year for her life payable solely from trust income, upon the death of the spouse the amount to be included in her transfers will be determined by use of a ratio of the annual annuity amount ($2,000) to the projected annual return under the Treasury tables calculated as of the original transfer ($100,000 x 6%, or $6,000). Assuming the value of the trust property upon the termination of the spouse's interest is $150,000, the amount includible as property in which the spouse held a current beneficial interest will be one-third or $50,000. Where the spouse's right is accompanied by a dis- cretionary power over the same fund to distribute principal to her and one or more distributions are made pursuant to *the power, the total amount included in her transfers may be greater than the amount determined by the application of the fixed ratio. Because the power is deemed applicable to the entire fund - not simply the portion to which the marital deduction relates a distribution will not reduce the portion to be included in the spouse's transfers at death on a dollar- for-dollar basis. For example, assume a separate fund of $1,000 and a right in the spouse deemed to relate to 60% of the fund; pursuant to a discretionary power the spouse re- ceives a distr.ibution of $100 from the principal of the fund. Assuming constant values and no dissipation of the $100 amount received, the spouse's transfers subject to tax will include the $100, as an amount she holds outright, and 60% of $900, the amount includible by reason of the prior marital deduc- tion. Thus, a total of $640 is included, although the spouse's interests in the fund gave rise to a marital de- duction of only $600. This result can be ameliorated only at the cost of unacceptable complexity. 3. Section 10 This section is the counterpart in the lifetime transfer provisions to Section 27. It requires the inclusion of property, for which a marital deduction was allowed, in an individual's transfers at any point during his life when his current beneficial interest terminates, by deeming the termination a transfer of the property. Absent a specific provision relating to such a termination, no tax liability would arise at that point because no other provision of the Draft would be applicable. Section 10 also contains the provision discussed above relating to the valuation of the right to receive fixed payments from a separate fund where a marital deduction was allowed for this right. -153- PAGENO="0237" 223 Section 11 Annual Per-Donee Exclusion This section significantly modifies and simplifies sections 2503(b) and (c), which, while appearing to be simple to apply, are quite complex and have resulted in considarable litigation Section 2503(b) provides an annual exclusion not to exceed $3,000 per donee for gifts of present interests in property Section 2503(c), first enacted in 19514, allows an annual exclusion for a transfer in trust for a minor if certain conditions are satisfied. It was enacted to create a vehicle for obtaining the exclusion without the use of a formal legal guardianship. We believe current law concerning the annual exclusion is both too liberal and too restrictive. Section 2503(b) is too liberal in allowing an exclusion for an income interest in trust as a "present interest". Further, there has been extensive litigation over whether a trust income interest is sufficiently "present" to qualify for the exclusion where the trust property is either non-income producing or produces only a small amount of income. The cases have reacheo contrary conclusions on basically indistinguishable facts Compare Rosen v Comm'r 397 F 2d 2145 (14th Cir 1968) with Stark v Unitea States, 3145 F Supp 1263 (W D Mo 1972) On the other hano, section 2503(c) is too restrictive in requiring a distribution of the trust property at an age (21) when the beneficiary may not be considered to have sufficient maturity to manage investment property wisely. The test for the availability of the exclusion should be based upon the transfer tax status of the donated property in the hands of the donee. If (and only if) the entire property would be included in the gross transfers of the donee upon his death immediately after the gift is made, the exclusion should be available. This approach was suggested in the American Law Institute's prior study of the estate and gift tax laws (Tentative Draft No. 10, April 30, 1955 at 11 127-28) The first sentence of oection 11 allows the $3 000 per-donee exclusion for outright transfers The second sentence establishes a special rule for certain types of transfers in trust or the equivalent -- transfers qualifying unoer this sentence are treateo as outright transfers for purposes of the exemption To qualify the transferreo property must be includible in the oonee's transfers at death if he were to oie immediately after the transfer thus a gift of a current income interest alone in a trust would not qualify (as it now does) for the annual exclusion In addition the aonee must be the only person who may have any interest in the property until his death -154- PAGENO="0238" 224 The second sentence of Section 11 reflects the language and approach used elsewhere in the Draft. The reference to a trust or its equivalent is taken from the headings of Sections 8 and 25, and the phrase should be given the same meaning. The terms "right" and "eligibility pursuant to the exercise of a power" are taken from Section 21, but the effect of their use here is broader because an exclusion is precluded in every case where there is a possibility of such an interest arising in another prior to the donee's death. In addition the time reference employed -- a death immediately after the transfer -- is the same as that used in the tests of Section 9 and 13. Section 11 continues current law in making the exclusion mandatory and in requiring that it be reduced in any calendar quarter by theamount which was allowable as an - exclusion in previous quarters of the same year. As a result, the exclusion must be applied against the first $3,000 of gifts to each donee in the calendar year. An exception is provided for interspousal transfers to cure a difficulty caused by the requirement of quarterly returns effective for gifts after December 31, 1970. At present if a transfer of $3,000 is made to a spouse in each of two calendar quarters, $1,500 of the second transfer is included in gifts subject to tax, because the annual exclusion must be applied in full against the first transfer and only 50% of the second quarter's transfer may be claimed as a marital deduction. To change this result, Section 11 provides that where the allowable marital deduction is based upon the percentage limitation rather than the fixed dollar limitation, the exclusion applies against the amount transferred reduced by the marital deduction. In the above example, a marital deduction of $1 ,500 would be available in each quarter, and the ex- clusion would thus be applied against the remaining $1 ,500 transferred in each quarter. The Draft provides a $250,000 fixed marital deduction before the percentage limitation becomes relevant (unless adequate records are unavailable), so the problem is not significant - Section 11, nevertheless, cures the inequity at no cost in terms of increased complexity for the few cases in which it might come up. The Studies (pages 361, 377) would continue current law on the annual exclusion. The ALl Project (pages 51, 120-21) proposes that the per-donee exclusion be retained at $3,000, but recommends that, if its proposed "transfers- for-consumption" exclusion (pages 19-21, 165-66) is adopted, the exclusion be limited to an aggregate of ~15,000 in any year. The Draft does not adopt the exclusion -155- PAGENO="0239" 225 for transfers for consumption Accordingly, the $15,000 limitation on the per.-donee exclusion has been rejected The ALl Project has summarized the argument in favor of a transfer~for-CoflsUXflPtiOfl exemption as follows (page 19): "The expenditure of funds by a member of a family in discharge of his legal obligations to support another member of the family does not involve a taxable gift for gift tax purposes and clearly should not The expenditures that are deemed in discharge of a legal obligation to support another, however, are determined on the basis of local law, and local law is neither uniform nor clear on this matter. Thus, to the extent the freedom from gift tax liability is founded on the legal-obligation test, the federal gift tax is imposed on some and not on others in identical circumstances, solely because there is a difference in their geographical locations." To avoid this result, the ALl Project recommends that the following transfers be exempt as transfers for consumption, whether or not they in fact involve a discharge of a legal obligation of support: (1) expenditures for a child of the transferor or any person residing in the transferor's household, provided the transferred property will not have any significant value one year after the transfer (2) payments for current educational, medical or dental costs of any person and (3) payment for the reasonable current cost of food, clothing and shelter for any person in fact dependent on the transferor for support. The ALl Project acknowledges that its proposal might involve difficult factual issues, and justifies it on the basis of "the larger benefit of excluding typical transfers that are motivated by considerations other than the build-up of wealth in the transferee". The extent of the problems which the proposal would cause is in our judgment, underestimated In this connection the complexities and litigation which the use of the single word `benefit" in section 2503(c) has created is worth noting A transfers_fOr~cOn5umPti0n provision would be difficult to interpret and administer, in view of the factual questions which would be involved We have rejected it for this reason. Sections 12 and 314 "Exemption~ Sections 12 and 314 provide separate (but to some extent interdependent) exemptions for transfers during life -146- PAGENO="0240" 226 and at death and replace section 2521, which grants a $30,000 gift tax exemption, and section 2052, which grants an estate tax exemption of $60,000. The use of the word "exemption" with reference to the estate tax is misleading. A deduction is involved, and the tax savings is the estate tax on $60,000 at the decedent's highest (marginal) tax rate. An exemption represents a policy decision that transfers of amounts below a certain level should not be taxed. There Is also the practical element that in such cases the government is spared the task of auditing returns for a relatively minor amount of tax and~the estate is spared the task (and the cost) of preparing such a returz~i, which because of its detail requires considerable tiMe. Exemptions should not be considered in a vaci~um, but rather in conjunction with the rate schedule. The first order of priority in this regard is to lessen the steep progression in the current lower estate tax rates, but within the general framework of a system that would produ.ie approximately the same amount of transfer tax revenue as is collected under current law. The loss of revenue from the more gradual progression in the lower rates set forth In Section 1 makes It impossible to accept a further revenue loss by increasing the exemptions and continuing to have them operate as deductions. On the other hand, there is merit in the argument that the current $60,000 estate tax exemption should be adjusted upward to reflect the substantial decrease in the purchasing power of the dollar since it was instituted. An exemption of about $150,000 would now be required if the exemption were to reflect the rise in the cost of living which has taken place since 19142. These competing considerations have been compromised in the Draft by shifting to a "credit" approach, which permits an increased exemption, but one that cam only be used against the lowest transfer tax rate. The Studies (page 357, 377) propose an exemption in the form of a deduction for $60,000. The transferor would be given the choice of how it should be used among his transfers. This approach has several disadvantages. First, it permits what people would consider an undue deferral of tax with respect to lifetime transfers - when viewed in the light of the availability of the annual exclusion, it may be argued that there is no sound policy reason why an individual should be permitted to transfer such an amount during his life without the immediate payment of some transfer tax. Second, it constitutes a reduction in t1~e $90,000 of exemptions now available under the gift and estate tax laws, even though these exemptions are clearly worth less now than they were several years ago. Third, the -157- PAGENO="0241" 227 68-872 0 - 76 - 16 exemption continues to be a deduction, with the tax benefit calculated at the transferor's marginal rate of tax. Fourth, use of the entire or a substantial part of the exemption during life will require an estate to file a return and pay a tax even where the amount involved is small It would be preferable to limit the amount of the total exemption that could be used during life to avoid this possibility The ALl Project (pages 50, 122-23) proposed an exemption of $100,000 for a unified tax This figure is based upon considerations of the general inflation which has occurred and the increased convenience for executors and the Internal Revenue Service which would follow from the reduction in the number of estate tax returns to be filed and audited. Section 3~I accepts the $100 000 figure as the maximum exemption for transfers at death, a $~40,000 increase over the current law for a person who makes no use of his lifetime exemption. It does so, however, by means of a credit against the Section 1 tax at death, which is the lesser of the actual tax imposed or $10,000 reduced by an amount equal to a 10% tax on the amounts deducted under Section 12. Thus the credit is related to the amount of the lifetime exemption actually used The minimum exemption for transfers at death will be $70,000 and the minimum credit will be $7 000 Section 12 continues current law by limiting to $30,000 the amount which may be claimed as an exemption for lifetime transfers. Section 12 and 3~ both provide that the allowable exemption will be reduced to reflect transfers made before the enactment of the Draft which were eligible for the lifetime exemption under section 2521 The rate schedule of Section 1 will, however, be applied as if no transfers had been made before the enactment of the Draft. Sections 1~ and 31 Charitable Deduction A Introduction The Tax Reform Act of 1969 (the Act) made signifi- cant changes in the estate and gift tax areas for transfers to split-interest trusts viz , trusts having both charitable ano non-charitable beneficiaries Prior to the Act an estate or gift tax deduction was available for a -158- PAGENO="0242" 228 charitable income interest in a trust or, in general, for a charitable remainder interest following an income interest In the case of a remainder interest, no deduction was allowed if the trustee had a power to invade principal for an individual unless the exercise of the power was limited by a fixed and ascertainable standard and the likelihood of invasion was so remote as to be negligible The changes made by the Act regarding charitable deductions for trust remainder interests resulted from the insertion of a limitation in sections 2055(e) (2), 2522(c)(2) and 170(f)(2)(A) to the effect that in order to obtain a deduction for such an interest one of the three new types of trusts - an "annuity trust" a "unitrust" or a "pooled income fund" - must be used These terms are defined in sections 66~4 and 642(c)(5) The changes made in sections 2055(e)(2) and 2522(c) (2) were recommended by the Studies (pages 366-67). Their rationale is explained in the General Explanation of the Act prepared by the staff of the Joint Committee on Internal Revenue Taxation as follows (page 83) "The rules of the prior regulations had the effect of allowing a taxpayer to receive a charitable contri- bution deduction for a gift to charity of a remainder interest in trust which was substantially in excess of the amount the charity might ultimately receive. This was because the assumptions used in calculating the value of the remainder interest bore little relation to the actual investment policies of the trust. For example, the trust assets could have been invested in high-income, high risk assets. This enhanced the value of the income interest but decreased the value of the charity's remainder interest. This factor, however, was not taken into account in computing the amount of the charitable contribution deduction. "Congress' attention also was called to the fact that in some cases charitable contribution deductions have been allowed for gifts of charitable remainder interests in trust even though it was likely that the gift would not ultimately be received by the charity. An example of this was a situation where the charity had only a contingent remainder interest in the trust (for example, a $5,000 annuity to A for life remainder to his children, or to a charity if A had no children). Another example was the situation where a charity had a remainder interest and the trust permitted invasion of the charitable share for the benefit of a noncharitable intervening interest which was incapable of reasonably certain actuarial valuation (for example, a $5,000 annuity to A for life, remainder to a charity, but the -159- PAGENO="0243" 229 trust provided that the trustee may pay A amounts in excess of $5,000 in order to maintain his standard of living) " Based upon our knowledge, the "manipulating" of split-interest trusts described in the first quoted paragraph to the detriment of the charitable beneficiary was extremely rare and occurred only when the trustee violated his duty of impartiality as between income beneficiaries and remaindermen. When present, it was usually found with a charitable income interest rather than a remainder interest. The second quoted paragraph is both inaccurate and misleading. Under prior law, a charitable deduction was not allowable in the first example and in the second example a charitable deduction was, as mentioned above, allowable only if the likelihood of invasion was so remote as to be negligible B The Problems With The Act Our experience since the passage of the Act has been that the restrictions inserted in sections 2055(e)(2) and 2522(c) (2) have resulted in a significant reduction of charitable giving through split-interest trusts. We concur with a statement made by an experienced attorney that "The sheer complexity of the new rules on `split- interest' trusts has caused some taxpayers to throw up their hands. Where a guy night have said, all the income to my wife, remainder to Harvard, today he's liable to say, oh, the hell with it. He leaves it all to his wife ahd gives Harvard $5,000 and Harvard never knows what it has missed." Wall Street Journal, December 29, 1971, page 1, column 5. Leaving aside the complexity issue, the two major difficulties in the charitable remainder trust area under current law are (i) the failure to allow a gift or estate tax charitable deduction for a remainder interest following an income interest and (ii) the use of an unrealistic and inflated 6% rate of return for valuing trust interests While we would prefer a return to the old law permitting a gift and estate tax deduction for a charitable remainder interest following an income interest, we recognize the problems presented by a complete reversal of a recently made policy decision. Accordingly, we suggest below changes which will make the "income" urxitrust permitted by section 661~(d)(3) work fairly so that it will be used more frequently This section contains an exception -160- PAGENO="0244" 230 to the definition of a charitable remainder unitrust in section 66k(d)(2). It permits the governing instrument (i) to direct payment of trust income, if less than 5% of the value of the trust property, and (ii) to provide for a "make-up" payment from trust income in any year in which the income exceeds the 5% amount, to the extent that payments in prior years under the trust income standard in (i) were less than the aggregate minimum amount required by section 66k(d) (2) (A). C. Proposed Changes We propose three substantive changes in the current law: (1) a lowering of the present rate of return prescribed in the Treasury tables; (2) the substitution in section 66L1(d)(3) of the Treasury tables rate as the upper limit for permitted annual payments in lieu of the current 5% standard of paragraph (2)(A); and (3) an addition to that section permitting an income beneficiary to appoint at his death or the earlier termination of the trust the excess of the projected return under the Treasury tables over the actual amounts previously distributed. The first change is a general one which will affect the valuation of interests in all split-interest transfers. The second and third changes amend section 66)4(d)(3) and affect only "income" unitrusts. In addition, three technical changes are proposed to section 6614(d)(3). All of these changes except the rate of return are put in statutory form at the end of this Qommentary on Sections 1k and 31. Finally, Sections 1k and 31 contain a provision prohibiting a charitable deduction when a marital deduction is allowed for a current beneficial interest in the same property. 1. Chamge in Rate of Return The effect of the present unrealistic 6% rate of return prescribed in the Treasury tables (the "Rate") is to overvalue an income interest and to undervalue a remainder interest in a trust. This is true fo.r all trusts, whether or not a charitable interest is involved I~owever, the effect of this distorted valuation is particularly acute for the "income" unitrust. The primary drawback to the use of this vehicle, which is close to the old income-charitable remainder trust, is that the 6% rate causes the value of the charitable remainder interest to be significantly understated. The Rate should be close to the "average" rate of return earned by trusts. We urge that It be decreased to ~4...1/2%. Our experience indicates that the "average" rate of return for trust investments does not exceed this figure. -161- PAGENO="0245" 231 We would point out that this change would not be a one-way street It would increase the value of the charitable remainder interest in the case of a unitrust but decrease the value of this interest when an annuity trust is used See Polasky, The Numbers Game - Using the Actuarial Ta~les in Estate Planning, U. Miami 5th Inst. on Est. Plan. ¶71 813 1 (1971) 2. Correlation of Payouts with Rate of Return This change in section 66!~(d)(3) correlates the amounts which a charitable remainder unitrust is permitted to distribute to non-charitable recipients and the amount projected as receivable by these beneficiaries when the gift of the charitable remainder was valued for purposes of the charitable deduction. While highlighted by the current disparity between the assumed and the "average" rate of return, the change would be significant in any case where the payouts to non-charitable recipients are less than the projected rate of return. The purpose behind the limitation of the "income" payments under current law is understandable. In order to protect the remainder interest, the maximum amount of income payable currently should be limited. However, the use of the 5% rate established by way of paragraph (2)(A) introduces a rate which is unrelated to the rate of return used to value the trust interests when the transfer is made. It should not be. The appropriate reference should be to the Rate. An amendment to section 66J4(d)(3) provides that notwithstanding the requirements of section 66k(d)(2)(A) and (B), the trust instrument may authorize a payout of the trust's current net income on an annual basis subject to a "ceiling" based upon the Rate An aggregate approach is used in order to allow a "make-up" of income payouts where payments in prior years were below the projected amounts but the payment for the current year exceeds the current value of the trust multiplied by the Rate. The operation of revised section 66'4(d)(3)(A), and its relation to the transfer tax valuation of the original transfer, may be illustrated as follows Assume a transfer by a grantor of $100 to a charitable remainder "income" unitrust. The trust earns $3 in its first year, and $10 in its second, its value has remained $100 The grantor is entitled to a transfer tax charitable deduction based upon application of the Rate in Table A(1) of Treas Regs §25 2512-9(f) The Rate will also act as the limitation on the maximum amount of income payable by the trust to a non-charitable beneficiary ("X"), in place of the current 5% -162- PAGENO="0246" 232 figure in section 66L~(d)(2)(A). In the first year the trust may pay to X the full $3 of trust income, since this amount is less than the projected $6 return using the Rate. In the second year, the current income, $10,. is aggregated with trust net income in prior years, resulting in a$13 figure; this figure is then compared with the projected return for the two years, $12, and the excess of the former over the latter, $1, must be retained by the trust and added to principal. This method permits a total payout of $9 in the second year, exceeding the projected rate of return for that year but matching the cumulative total of amounts which would have been payable over the life of the trust to that time had the projected 6% net return actually been earned by the trust. Under current law, a payout of only $7 would be permitted to the recipient in the second year 3. Power of Appointment This change adds a subparagraph (B) to section 664(d)(3) which permits a payout of the difference between the projected return under the Rate and the amounts previously distributed from the trust to the "income" recipients. The difference is distributable pursuant to a general power of appointment held by a recipient exercis- able only on the first to occur of the termination of the trust or the death of the power holder. Each recipient may be given such a power, regardless of whether he is the sole recipient or whether his power follows a similar one held by a prior recipient, and the power extends to amounts attribu- table to years before the power holder was a recipient. This change assures that the amounts in the trust which have not been paid out but which were part of the projected payouts used to calculate the grantor's taxes may be withdrawn from the trust for non-charitable recipients. The amount subject to the power will be included in the gross estate of the power holder whether or not the power is exercised. Any amount paid to an appointee will be subjected to income tax under the rules of section 6614(b) and is intended to be treated as income in respect of a decedent under section 691. ~4 Technical Changes to Section 661k A technical change strikes the opening words "Nothwithstanding any other provision of this subchapter" from the general rule of section 66)4(a). This change is intended to make it clear that the Treasury's authority to promulgate regulations concerning section 66)4 extends to sections beyond the subchapter. -163- PAGENO="0247" 233 A second change amends subsection (b) to refer to subsection (d)(3) in order to make it clear that amounts received pursuant to the exceptions of that subsection will be characterized in accordance with the rule of subsection (b). A third change adds a new subparagraph (C) to subsection (d)(3) providing that the payment to a federal, state or local governmental unit of death taxes imposed upon a charitable remainder trust by reason of the death of an "income" beneficiary will not be considered payment to a non-charitable recipient. This change is required as a result of the new subsection (d)(3)(B) permit- ting a distribution pursuant to a general testamentary power of appointment. The property subject to the power is includible in the power holder's gross estate, whether or not he exercises the power. Where he chooses not to exercise the power, an offsetting charitable deduction, which would cancel the effect of the inclusion, may not be available because any subsequent "income" recipients may also have the same power making it unclear whether the subject property will actually be received by the charity. In thi~s situation, the power holder's other property should not be forced to bear the burden of death taxation resulting from inclusion of the trust property in his transfers at death. The trust's exemption should not be open to question when it makes a payment of tax and there should be rio question of a constructive distribution to the estate by reason of that payment. In view of the strict wording of paragraph (1)(A) and (B) and (2)(A) and (B), a statutory provision is needed to eliminate these issues in connection with a payment of death taxes The subparagraph does not permit a payment in excess of the allocable death taxes which are imposed on the trust assets -- a beneficiary's direction that the trust pay any part of the tax attributable to his other transfers at death will not be protected by this provision. 5. Sections 14 and 31 These sections continue sections 2055 and 2522, A paragraph (3) has been added to each (sections 2055(e) and 2522(c)) to provide that no charitable deduction is allowable for an interest in property which forms the subject matter of a marital deduction by reason of the same transfer This provision precludes a double deduction (a marital deduction and a charitable deduction) for the same property, in the case of a charitable remainder trust where the grantor's spouse is the "income"beneficiary In addition, Section 31 changes section 2055(c) to require reduction in the allowable charitable -164- PAGENO="0248" 234 deduction only for the amount of the Section 1 tax; the allowable charitable deduction for purposes of the basic tax on transfers at death will not be reduced by the amount of the AET imposed under Section 2. D. Imposing a Limitation on Amount of Charitable Deduct ion Although neither the ALl Project nor the Studies proposed a limitation on the amount of the charitable deduction for transfer tax purposes, there have been suggestions made from time to time that these deductions should be limited to a specified percentage of all the property transferred by the individual c~uring the taxable period involved or at death. See, ~ Westfall, Revitalizi~ig the Federal Estate and Gift Taxes, 83 `Harv. L. ~ 936 1OO5-O~ (197O1~iection 6O~(a) of H H 1O~IO (the Tax Equity Act of 1973). We have rejected such a limitation. It should, however, be pointed out that the AET imposed by Section 2 does not contain a general exemption for charitable transfers. Thus, in the case of an estate with unrealized net appreciation, the AET limits the amount that can be transferred to charity free of transfer tax. The effect of this limitation is lessened by the fact that the Section 1 tax is. computed without giving any consideration to the AET. Amendments to Section 6614 (b) Character of Distributions Amounts distributed by a charitable remainder annuity trust or by a charitable remainder unitrust shall be considered as having the following characteristics in the hands of a recipient to whom is paid amounts described in paragraphs (1)(A),(2)(A), and (3) of subsection (d): [section 6614(b)(1), (2), (3) and (14), and final sentence of section 6614(b)]. (d)(3). Exceptions. (A) Notwithstanding the provisions of paragraphs (2)(A) and (B), the. trust instrument may provide that the trustee shall pay the income beneficiary for any year the net income of the trust, except that if the sum of such net income and the net income for all prior years exceeds the aggregate of the net fair market value of the trust assets, valued annually, multiplied by the percentage applicable to the valuation of such benefi- ciary's interest when first subjected to tax under subtitle B of this Title, such excess (reduced by the amount of all previous additions to the principal of the trust pursuant to this paragraph) shall be added to the principal of the trust. -165- PAGENO="0249" 235 (B) Notwithstanding the provisions of paragraphs (2)(A) and (B), the trust indenture may provide that amounts may be distributed pursuant to a general power of appointment (as defined in [section 22]), (a) held by a recipient of the payments described in subparagraph (A), and (b) exercisable upon the first to occur of the termination of the trust or the death of the recipient, which do not exceed an amount equal to the aggregate of the net fair market value of the trust assets, valued annually, multiplied by the percentage applicable to the valuation of the property transferred to the trust for which a deduction was allowed under section 170, [14] or [31] of this Title when first subjected to tax under subtitle B of this Title, less amounts previously distributed under this paragraph. (C) Notwithstanding any provisions of this Title, a payment by a trust described in this subsection to the United States or to any state or local governmental unit as estate, inheritance, succession or other death taxes imposed upon such trust or its assets by applicable law shall not be considered a payment to or for the use of any person other than an organization described in section 170(c). Section 16. Disclaimers A. Introduction The current gift and estate tax laws do not contain a definition of the term "disclaimer" or a provision of general application establishing the tax consequences of disclainers. A disclaimer is, however, treated in certain specific instances as other than a receipt of an interest in property followed by a transfer by the recipient Sections 20)41(a)(2) and 2514(b) provide that a disclaimer or renunciation of a general power of appointment is not deemed a release which is a taxable event and sections 2055(a) and 2056(d), relating to the estate tax charitable and marital deductions respectively provide that for the purpose of these deductions property is deemed to pass from the transferor directly to the person who receives it by reason of I disclaimer Treas Regs §25 2511-1(c) is also significant and states: Where the law governing the administration of the decedent's estate gives a beneficiary, heir, or -166- PAGENO="0250" 236 next-of--kin a right to completely and unqualifiedly refuse to accept ownership of property transferred from a decedent (whether the transfer is effected by the decedent's will or by the law of descent and distribution of intestate property), a refusal to accept ownership does not constitute the making of a gift if the refusal is made within a reasonable time after knowledge of the existence of the transfer. The refusal must be unequivocal and effective under the local law. There can be no refusal of ownership of property after its acceptance. Where the local law does not permit such a refusal any disposition by the beneficiary, heir, or next-of-kin whereby ownership is transferred gratuitously to another constitutes the making of a gift by the beneficiary, heir, or next-of-kin. In any case where a refusal is purported tO relate to only a part of the property, the determi- nation of whether or not there has been a complete and unqualified refusal to accept ownership will depend on all of the facts and circumstances in each particular case, taking into account the recognition and effec- tiveness of such a purported refusal under the local law. In the absence of facts to the contrary, if a person fails to refuse to accept a transfer to him of ownership of a decedent's property within a reasonable time after. learning of the existence of the transfer, he will be presumed to have accepted the property." Thus the gift tax consequences of a disclaimer turn upon its effectiveness under local law. Local law is not uniform and is not always clear. Recently several states have enacted disclaimer legislation. See N.Y.E.P.T.L. §L~-1.3; Laws of Florida 1971, chs. 71-31 and 71-33, enacting sections 689.21 and 731.37, effecti.ve October 1, 1971; Illinois Annotated Statutes, ch. 3 §15b-d and oh. 520 §~211-213., enacted by Laws 1961, at 518 §~1 et ~g. and 520 §~1 et ~~a* (May 19, 1961); Michigan PublicTct No. 9, enacting MI~higan Complied Laws Annotated §~55tt.5O1 - .520, effective January 1, 1972. A primary objective of this legislation is to liberalize and clarify disclaimer rules so as to permit disclaimers to be used without adverse gift tax consequences. B. Subsection (a). This subsection deals with the tax consequences of a disclaimer, as defined in subsection (b), to the disdaining party and to the transferor. With respect to the former, subsection (a) provides that "he shall not thereby be deemed to have made a transfer"; thus the property will not be included in his transfers subject to tax. -167- PAGENO="0251" 237 As to the transferor, subsection (a) directs that the disclaiming party shall not be deemed "to have possessed the [renounced] interest, for the purpose of this chapter" thus the property will be deemed to pass directly from the trans feror Subsection (a) makes the specific cited provisions of current law unnecessary and they are not continued in the equivalent sections of the Draft. A transferor may provide in the instrument of transfer for the redirection of the property in the event of a disclaimer. Absent such a redirection, the recipient of a disclaimed interest would be determined under applicable local law. C, Subsection (b) The term "disclaimer" is defined in subsection (b) as the "irrevocable and unqualified refusal by an individual in accordance, with local law to accept, in whole or in part, an interest in property." To qualify as a disclaimer the refusal must be in a written statement filed with the transferor, his legal representative, or the person who holds at that time the legal title to the property to which the refusal relates. The disclaimer must be made within 9 months of the individual's interest becoming indefeasibly fixed. The 9-month period corresponds to that provided for the filing of the return for transfers at death. Finally, prior to the refusal, the individual must not have waived his right to disclaim or accepted any benefits from the property pursuant to the interest which he disclaims. The words of the subsection "indefeasibly fixed" are drawn from a Model Disclaimer Act drafted by a Special Committee on Disclaimer Legislation of the Real Property Probate and Trust Law Section of the American Bar Association. The Draft omits the words "both in quality and quantity" in the Model Disclaimer Act as unnecessary. The full wording of the Model Act is used in the Florida, Illinois and Michigan statutes mentioned above In describing the meaning of these words the Special Committee states "The phrase is intended to gear the commencement of the period [within which a disclaimer may be made] to a time when the existence and extent of the disclaimant's interest are fully established and defined The verb `fixed' is employed rather than `vested' to avoid the lack of precision in meaning which the term `vested' involves " Under this provision an individual who holds a remainder or similar interest in property may without -16 8- PAGENO="0252" 238 adverse transfer tax consequences, postpone renouncing his interest until it becomes fully possessory. See Estate of ~ 113 N.J. Super. 582, 274 A.2d 614 (1970). This position changes current case law under which the disclaimer will be treated as a transfer for gift tax purposes unless it is made within a reasonable time after the disdaining person learns of the existence of the interest. See Pauline Keinath, 58 T.C. 352 (1972), on appeal to the Eighth Circuit. An interest in property held jointly which arises pursuant to a right of survivorship will, under subsection (b), not be considered as having become indefeasibly fixed until a co-owner is entitled to receipt of the entire property by reason of his having survived his co-owners. Thus a disclaimer of property received through a right of survivorstiip need not be made prior to the maturing of this right. In this respect the Draft reverses current law. See ~ Krakoff v. United States, 439 F.2d 1023 (6th Cir. 1971). The ALl Project (pages 95_97) proposes that an incompetent be deemed incapable of learning of his interest until his incompetency is removed, thus permitting him to disclaim within six months thereafter. Such a provision was rejected in the Draft because the situations to which it would be applicable would arise only infrequently and because the transfer tax consequences of the original transfer could remain uncertain for an undesirable length of time. The Studies do not appear to have considered this issue. The Studies (pages 365-66, 387) also propose that federal standards for disclaimers be established. The ALl Project and the Studies recommend that the person making a disclaimer be permitted to direct the destination of the property in his disclaimer. This recommendation has been rejected as being inconsistent with an underlying premise of the Draft that control over property should give rise to a tax to the person having such control. The power to redirect constitutes control over the property similar to a general power, and should be treated similarly, whether or not the recipient derives a benefit from the property Consideration was given to the proposal in the ALl Project (page 96) that, where a transferred interest terminates on the death of the transferee, his death will be regarded as a disclaimer of his interest, if immediately prior to his death he could have disclaimed the interest and his representative so elects. This proposal would preclude the "forcing" of a transfer on an individual by reason of his death at a time when he might otherwise have chosen to -169- PAGENO="0253" 239 reject the transferred interest However, it would permit an executor to reduce the transferee's estate, with a savings in transfer taxes, in cases where one or more of the recipients of the property by reason of the disclaimer might be beneficiaries of the estate as well The Draft takes the position that a disclaimer should be in all cases an affirmative act on the part of the recipient alone, i e , that death should not be considered the equivalent of a personal act of refusal by the recipient Thus if a recipient dies at a time when he could have disclaimed but had not done so, he will be deemed to have accepted the transfer. This rule is simple and also avoids "conflict-of-interest" situations for the executor where the beneficiaries of the estate are similar to but not the same as the recipients of the property in the event of a disclaimer. Section 17. Taxable Transfers. This section is the general provision taxing transfers at death. It replaces sections 2031(a) and 2051, defining the terms "gross estate" and "taxable estate", respectively, and includes the limitation of section 20143(a) concerning transfers made for less than a full and adequate consideration in money or money's worth. Section 2031(b), relating to the valuation of unlisted stock and securities, is omitted as unnecessary. Sections 20143(b) concerning marital rights as consideration is covered in Section 29(a)(2) of the Draft. Section 17 provides that the transfer tax is applicable to the total value of all transfers described in Sections 19 through 28 of the Draft in excess of any consideration in money or money's worth received therefor Thus, unlike Section 3, the comparable provision for lifetime transfers, Section 17 does not relate to includibility - the transfer must first be includible in transfers at death under another provision before this section will apply. Taxable transfers are computed by reducing the transfers at death by the amounts deductible under Sections 29 through 33, concerning (1) disbursements (2) losses (3) charitable transfers (~) marital transfers and (5) property previously taxed The rate schedule of Section 1(b) is then applied to the resulting figure Section 18 Alternate Valuation This section continues current law on the alternate valuation date, with one change the words -170- PAGENO="0254" 240 "distributed" and "distribution" are deleted from section 2032(a) and a new general rule is added that a distribution by the executor or a trustee to a beneficiary will not be considered a sale, exchange, or disposition of the property. This general rule will not apply if the distribution gives rise to the recognition of gain or loss for income tax purposes. If a distribution results in gain or loss, it is in reality a sale or exchange. Since such a distribution results in an altered tax basis for the property, it is an appropriate point at which to fix the value of the trans- ferred property for transfer tax purposes. The change will permit the executor to make distributions unaffected by alternate valuation considerations. Currently, the executor is "forced" to hold the property' until after the six month alternate valuation date expires in order to be in a position to minimize estate taxes. This change also changes current law for distributions from trusts (see Rev, Rul. 73-98, I.R.B. 1973-8,11). If the distributee sells or exchanges property he has received within six months of the decedent's death, the property's alternate valuation will be its value on the date of sale or exhange. Section 19. Property in which Individual Has an Interest. This section provides that an individual's transfers at death include the value of all property to the extent of his interest therein at his death. It is the same as section 2033, with one exception, and covers beneficially-owned property interests. Interests which terminate as a result of the death of the beneficial owner are not taxed under Setlon 19. This continues current law. See, ~ Revenue Ruling 55-439, 1955-2 Cum. Bull. 601; United States v. Estate of Farish, 360 F.2d 595 (5th Cir. ¶966). The mét~d~d of disposition at death, whether it is by will or through intestacy, is immaterial. The Studies (page 373) and ~LI Project (page 94) indicate an intent to retain current law. Interests which are technical or contingent reversions in a grantor are included in his gross estate' under section 2033, with the amount to be taxed turning on whether the interest so included Is susceptible of valuation. See Rev. Rul. 67-370, 1967-2 Cum. Bull. 324; Estate of James H. Graham, 46 T.C. ~4i5 (1966). In Graham ~E~é~ecedent-grantor had failed to Include In a trust indenture provisions for the ultimate disposition of the trust property upon the death of the last measuring life, giving rise to a technical reversion; his two daughters, who were also measuring lives, were empowered to elect to -171- PAGENO="0255" 241 terminate the trust, but only if either should survive his death by more than 6 years -- unless they so elected or if they did not survive him by six years, the property would pass to his estate. The Tax Court held that the $l,~488.58, the value attributable to the likelihood that neither of the daughters would survive their father by six years, was taxable under section 2033. A case such as Graham arises infrequently and then usually through ignorance or an accident in draftsmanship These situations should not give rise to a transfer tax if the full value of the property was subjected to tax at the time of the original transfer. Accordingly, Section 19 modifies current law and excludes from its coverage all interests held by a transferor at his death in property he transferred during his life, unless the interest is certain to become possessory at a later time. This approach places the focus for the taxation at death of all retained interests on Section 21, where it belongs. A transfer to which Section 21 is not applicable at death will have been fully taxed prior to the transferor's death because the inter vivos deduction of Section 13 will not have been available. Section 23. Employee Benefits Section 2039 deals with the treatment of annuities and employee benefits other than life insurance In the case of such benefits payable from a qualified plan, it applies only to the portion of payments receivable by reason of an individual's death which are attributable to his own contributions - the portion attributable to the employer's contributions escapes estate tax. This result has been criticized. The Studies state (page 363) "There is no justification for this preferred tax treatment for an asset that clearly' is part of the decedent's total wealth. . . and propose (page 376) that the employee be treated as making a death-time transfer to the recipient of the benefits, including those from employee annuities, employee benefit plans (qualified or nonqualified), group-term life insurance proceeds, or any other cash payments by the employer, whether voluntary or pursuant to contract. The ALl Project (pages 15-16, 115-16) also takes the position that there should be no exclusion from transfer taxation for employee death benefits but would not tax voluntary payments made by the employer In view of the unlimited marital deduction proposed in both the Studies and the ALl Project the inclusion of these death benefits in the employee's transfers at death would not result in an immediate transfer -172- PAGENO="0256" 242 tax being payable whenever the benefits are receivable by his spouse. We believe that as a general rule employee benefits should be included in an individual's transfers at death, and Section 23 establishes a general rule of includibility. We also believe that employee benefits receivable by the decedent's surviving spouse should qualify for the marital deduction without regard to amount if the plan is given a favored income tax treatment. In this way, the transfer tax will still contain a slight incentive to encourage the development of such plans. Since the Draft does not include an unlimited marital deduction, Section 32(a)(2)(C) establishes a special rule so that the receipt by a spouse of employee benefits under plans which currently receive favored income tax treatment will be disregarded in computing the allowable marital deduction. The proceeds of group-term life insurance, whether or not arising from an employment relationship, receive the same treatment as employee benefits, but are covered by Section 26 relating to life insurance. The lifetime desig- nation of a beneficiary will not be taxed whether an employee benefit or group-term life insurance is involved, because a deduction under Section 13 will be available by reason of the mandatory inclusion of these items in the employee's transfers at death. Accordingly, no reference to these benefits or group-term life insurance is needed in the inter vivcs previsions of the Draft. Lastly, the current rule of section 2039 as to annuities and similar payments which are not derived from employment is not continued. Such amounts will be includible in the individual's transfers at death under other provisions of the Draft. Section 23 will eliminate some of the interpretive difficulties which have arisen under section 2039. One of these is the issue.of whether the decedent was entitled to receive "an annuity or other payment", which is a prerequisite to the sections applicability For example, in Estate of Firmin Fusz, 46 T.C. 214 (1966), the decedent had iii~btiated an employment contract with his employer, a corporation in which he had about a one-third interest; the contract provided no post-employment benefits as such for anyone, but required payments of $200 per month to the decedent's widow if he died while employed. The Tax Court held that the payments did not fall within section 2039. In a later case, Estate, of Harold Fried, 54 T.C. 805 (1970), the Tax Court ü~held inclusion of amounts, receivable by a widow and designated "death benefits" in an agreement between co-partners, under section 2037. The court intimated that inclusion by way of section 2039 might also be Justifiable, 54 T.C. at 822, n. 6, referring to cases, -173- PAGENO="0257" 243 such as Fusz, on both sides of the issue. Under Section 23, the fact that the payment was derived from an employment relationship causes the payments to be considered for transfer tax purposes as coming from the decedent employee. Section 23(a) contains the general rule of includibility, and the definition of employee benefits. Under this subsection, the individual's transfers at death include the value of all employee benefits, defined as all amounts, other than life insurance proceeds (covered by Section 26), which become payable (i) by reason of the death of an individual (ii) pursuant to a plan or agreement (iii) derived from or connected with such individual's employment. The first requirement is obvious and needs no further discussion if the amount in question does not become payable or receivable by reason of a death, it is dealt with under other provisions of the Draft, either as an inter vivos or deathtime transfer. An employment benefit is an amount receivable pursuant to a plan or agreement. Thus voluntary payments made by an employer on the death of an employee are excluded. When an employer regularly makes such payments, however, it is intended that this practice be deemed to constitute a plan or agreement. See Estate of W. E. Barr, 1~0 T.C. 227 (1963); Estate of Bernard L. Porter, 5~4 T.C. 1066 (1970); Gray v. United States, k19 P.2d 109i4 (3d Cir. 1968). The final requirement is that the plan or agreement be "derived from or connected with" the decedent's employment. Thus the payment or benefit must grow out of the decedent's status as employee, i.e. it must be traceable to a compensatory relationship. Subsection (b) establishes two exceptions to subsection (a) amounts will not be includible in transfers at death as employment benefits if they constitute survivors' benefits under the social security acts, or the companion railway employees~ retirement acts, unless the decedent had the right at his death to designate the recipient of these amounts. The treatment of social security and railroad retirement benefits under the Draft continues current law. See Rev. Rul. 67..277, 1967-2 Cuin. Bull. 322. We believe that the current law is appropriate because the programs under which they become payable are generally involuntary in nature. To the extent that the decedent has a right under one of these programs to determine the payees, the exception will not be available - this conforms with the overall approach of the Draft that a right to affect the beneficial enjoyment of property is sufficient justification to impose a tax. Section 23 thus reflects the distinction drawn in Revenue Ruling 60-70, 1960-1 C.B. 372, concerning the treatment under section 2033 -174- 68-872 0 - 76 - 17 PAGENO="0258" 244 of Railroad Retirement Act payments. In this ruling, the Service held that benefits under section 5(f)(2) of the Act, for situations where no benefits would otherwise be payable, were taxable in the railway worker's gross estate under section 2033 because he could designate the beneficiary of these amounts, whereas the benefits receivable under other sections of that Act were not taxable in the estate under section 2033 or 2039. The exception in subsection (b) is inconsistent with the position taken in the ALl Project, which states (page 116) without further comment that "Amounts payable on the death of a person under social security are employee death benefits for the purposes of this Subsection [concerning the treatment of an employee as transferor of employee benefits] " The Studies do not appear to have specifically considered the treatment of social security and railroad retirement benefits (pages 363-6~4, 376-77). Section 26 Life Insurance A. Introduction Section 26 deals with the circumstances under which the proceeds of insurance policies upon an individual's life will be included in his transfers at death It does not apply to the transfer by an individual of an insurance policy on the life of another. The nature of a life insurance policy makes the establishment of transfer tax rules concerning it difficult. In part the difficulty is caused by the subs~tantial increase in the value of the policy upon the insured's death. Currently, on the lifetime trans fer of an ordinary life policy, the interpolated terminal reserve value, typically much below the policy's face amount, is subjected to tax. Since~a term life policy has no interpolated terminal reserve value, the lifetime transfer of such a policy gives rise to no immediate transfer tax. If the transferor - insured dies within three years of the transfer, the proceeds may be includible in his gross estate as a transfer in contemplation of death under section 2035; otherwise, they are not taxed upon his death unless he retained an "incident of ownership" in the transferred policy or the proceeds are payable to his executors. B Section 26 1 In General Section 26 has three subsections. Subsection (a) -175- PAGENO="0259" 245 replaces section 20t~2. It requires the inclusion in transfers at death of group-term life insurance, and continues the current rule of section 20142 for other kinds of life insurance -- the proceeds are includible where they are receivable by the executor or where the insured retained an incident of ownership in the policy at his death. Subsection (b) replaces section 2035, relating to transfers in contemplation of death, for life insurance proceeds. It requires inclusion of proceeds not otherwise includible under subsection (a) where the decedent transferred the policy within two years of his death. Subsection (c) codifies existing case law to the effect that the insured's possession of incidents of ownership exercisable only in a fiduciary capacity will not result in taxation of the proceeds on his death unless he can derive an economic benefit from the exercise of such incidents. 2. Subsection (a) Subsection (a)(i) provides that, with one exception, an insured's transfers at death include the proceeds of group-term life insurance. The scope of inclusion under subsection (a)(i) is broader than group insurance growing solely out of an employer-employee relationship. Thus, such insurance obtained through membership in a professional organization -- such as a bar or medical association -- would be covered. The subsection contains an exception for the proceeds of group-term insurance to the extent receivable by a present or former employer of such individual in his status as such. In these cases, the policy is intended to benefit the employer and recompense him for the loss typically of what he considered to be a "key" employee -- absent some benefit to the decedent's beneficiaries, either directly or through use of the proceeds to discharge obligations which would otherwise reduce the decedent's assets, it is not appropriate to include the property in the decedent's transfers and thereby to increase their exposure to transfer tax liability. Because, prior to the insured's death, group-term insurance has no value which can be reduced to a cash amount, taxation on a lifetime transfer of the policy by the insured is neither logical nor economically realistic. Since there is no benefit of substance to the transferee from the transfer prior to the insured's death, the transfer should be viewed as occurring at death regardless of the time the transfer actually occurred under local law. This is consistent with the treatment provided in Section 23 for employment benefits other than life insurance, and is appropriate in non-employment situations as the most practical method of reaching these amounts under group policies which would otherwise escape transfer taxation -176- PAGENO="0260" 246 entirely. The impact of this rule is lessened somewhat because group-term insurance may qualify for an "additional" marital deduction of up to $50,000 under Section 32. The ALl Project and the Studies proposed to tax term life insurance obtained through employment by in effect prohibiting the transfer of the policy during life for transfer tax purposes This approach is followed in the Draft and extended to include all group-term life insurance. The Draft does not alter the present treatment of individual term life insurance. Although the same reasoning would apply to both individual and group term, we do not believe that there is a significant level of abuse currently with respect to individual term policies or that there is a serious potential for abuse. Additionally, the rapid rise in the use of group-term insurance through employee benefit plans and many common commercial credit arrangements such as house or automobile financing warrants a departure for this insurance from the general approach of the Draft - that tax is to be imposed when the transferor releases his last beneficial right in or power over the property transferred - which is not warranted for individual term life insurance Subsection (a)(ii) requires the inclusion in transfers at death of proceeds receivable by the insured's executor, or by any other beneficiary where the insured held an incident of ownership in the policy at his death -- it thus retains the operative language of section 201~2(1) and~ (2). The subsection continues the use of the term "incident of ownership" to describe the rights in and powers over a policy upon which inclusion in transfers at death is based. The term is familiar, having been in the estate tax law for many years, and encompasses rights and powers which are otherwise difficult to categorize The meaning of this term is clarified in subsection (c) However, subsection (a) eliminates as an incident of ownership a reversionary interest in the policy which exceeds in value 5% of the policy's value immediately before the insured's death This elimination is taken from a recommendation of the ALl Project (pages 17-18, 10~4-05). The arguments in favor of the change are summarized as follows (page 17): "The reversionary interest as an incident of ownership is something of a trap in connection with the transfer of the ownership of a policy, and the 5% test is extremely difficult to apply Elimination of the reversionary interest as an incident of ownership would not create any significant tax loop~.hole and it would simplify the law." -177- PAGENO="0261" 247 We agree with this statement and believe that there is no sound reason to warrant a continuation of current law in this respect If this change is made a reversionary interest should not be treated as a retained interest with respect to a lifetime transfer of the policy by the insured and should not be considered in placing a value on a policy so transferred - if the policy thereafter reverts to the insured it will again constitute an asset of the insured subject to tax upon a subsequent transfer Currently, the possession of an incident of ownership in a life insurance policy exercisable by the insured only with the consent of another will cause the proceeds to be included in the insured's gross estate, irrespective of the limitation on exercisability. See Treas. Regs. §2O.2O42-1(c)(~4). The ALl Project recommends that, if the exercise of an incident of ownership requires the consent of anyone who has a "substantial interest in the policy that would be adversely affected by such exercise" the incident be deemed possessed solely by the individual who has such substantial interest. This recommendation is rejected in favor of continuing current law This change would conflict with the theory of the Draft, as evidenced by Section 21, that atax may appropriately be imposed on any property over which the decedent retained to his death any element of control. 3. Subsection (b) Under this subsection life insurance proceeds are includible in transfers at death if incidents of ownership were transferred within the two years preceding the transferor-insured's death and by reason of the transfer the proceeds will not be includible in his transfers at death under subsection (a), i.e., if the transfer is a complete divestment of all incidents of ownership in a policy the proceeds of which are payable to someone other than the executor. The divestment of the last incident of ownership will also be the occasion for the imposition of the transfer tax since the term "incident of ownership" under the Draft connotes a beneficial interest or power, the transfer of which would constitute transfer of the insured's last right or power. The lifetime transfer will thus give rise to a transfer tax on the interpolated terminal reserve value - the same result as under current law and we believe a sound one. This is also in accord with the position of the ALl Project, which proposed no changes in the treatment of life insurance other than that obtained through employment Since, however the lifetime transfer will have caused inclusion of a portion of the policy's value in the insured's transfers, the proceeds includible at death under this provision are reduced by the dollar amount previously -178- PAGENO="0262" 248 included, typically the interpolated terminal reserve value. The amount paid in transfer taxes upon the lifetime transfer is returned to transfers at death under Section 28. The total effect of these provisions is to treat the transfer as if completed upon the death of the insured. Subsection (b) is a modification as to life insurance of the contemplation of death rule under section 2035. The present rule, embodying a rebuttable presumption that a transfer within three years of death was made in contemplation of death, was made necessary by the Supreme Court decision in Heinerv. Donnan, 285 U.S. 312 (1932), holding an irrebuttable presumption of a motive to transfer in contemplation of death with respect to transfers made within a certain period preceding death unconstitutional as part of an estate tax. For several reasons, we do not believe that this decision precludes the approach of subsection (b). First, the subsection is applicable only to the proceeds of a life insurance policy, a unique asset whose nature warrants special treatment where substantial tax avoidance is otherwise possible. Second, by~use of a single transfer tax rate schedule, the question of whether an essentially inter vivos transfer can be made the subject of an estate tax is mooted - the issue becomes one of valuation of a transfer and of timing the imposition of the tax. It is perhaps significant that at the time Donnan arose, there was no gift tax in effect. Third, the subsection is not based upon the transferor's intent, a factual question, or upon a presumption, but rather is grounded on the belief that the proceeds of a life insurance policy should be taxed to the insured-transferor in any case where they become payable less than two years after the transfer. Section 603 of H.R. 101W (The Tax Equity Act of 1973) would reinstate the premium payment test, which was repealed by Congress in 195~4, for determining the amount to be included in the gross estate when some or all of the premiums on a policy have been paid directly or indirectly by the insured. The amount of the includible proceeds would be the proportion thereof which the aggregate premiums paid by the insured bear to the total premiums paid. The Studies (pages 362, 37~-75) propose a significant revision of the current contemplation of death rule as to life insurance. If the insured makes a complete transfer of a life insurance policy more than three years before his death, but pays premiums on the policy within the three-year period, the Studies would require inclusion in his transfers at death of (1.) the increase in cash value attributable to those premium payments and (2) the -179- PAGENO="0263" 249 difference between the face amount of the policy and its cash value at date of death (referred to in the Studies as the "protection element" of the policy). Payment of a premium on a term policy within three years of death would be treated as a transfer in contemplation of death equal to the full face amount of the policy. Also, an insured would be treated as paying the premiums on a policy if he or his spouse makes cash gifts or loans to the owner of the policy during the three years preceding death The Draft rejects the inclusion of any portion of the proceeds of an ordinary life insurance policy by reason of the insured's direct or indirect payment of premiums The premium payment test ignores the fact that a transfer of any form of life insurance other than term insurance prior to the insured's death conveys real and immediate rights to the transferee having a readily ascertainable value. The subsequent payment of premiums by the insured does not indicate the retention by him of any right in, power over, or connection with the transferred policy or the anticipated proceeds on the contrary, it indicates only that additional gifts in the form of direct payments to the insurer were made by~ the insured. The test would require tracing the source of funds used in premium payments, an undesirable result in itself, and would create a disparity in treatment among beneficiaries based solely on whether they could afford to pay the premium themselves The proposal of the Studies is, in reality, an attempt to re-establish the premium payment test for a life insurance policy transferred more than three years before death to include part of the proceeds of the policy in the insured's transfers at death. This test was eliminated by Congress in 195k. The attempt to re-establish it should be rejected for the same reasons, and for those set out in the preceding paragraph. ~. Subsection (0) This subsection clarifies the scope of the term "incident of ownership" as used in subsections (a)(ii) and (b) and has the effect of codifying the construction placed upon this term by two courts. See Estate of Fruehauf V. Comm'r, L~27 F.2d 80 (6th Cir.197Q),~ã Estate of Hector~.R. Skifter, 56 T.C. 1190 (1971), aff'd, ~ ~nd cir7~ 1972), 72-2 U.S.T.C. ¶12,893, These cases dealt: with situations in which the policies were held in trust and the insured was acting as a trustee. In Fruehauf, the court included the proceeds in the insured's estate because he was a life beneficiary of the trust and by reason of his exercise of the incidents of ownership as trustee he could affect his beneficial interest In Ski~~, the court held the proceeds were not includible in the insured's estate because he had no beneficial interest in the trust and thus -180- PAGENO="0264" 250 could not have exercised the incidents of ownership for his own benefit. The court in Fruehauf, said of these situations Accordingly, we decline to hold that mere possession by a decedent of any powers in the nature of incidents of ownership in a fiduciary capacity invariably requires inclusion of the proceeds of the policies on the decedent's life in his gross estate (1427 F 2d at 85) We agree with the results and the analyses in these cases -~ inclusion should turn on whether, the power or rights held confer an economic benefit on the insured. However, the Treasury regulations (~20.20142-1(c)(J4)), read literally, compel the opposite result "A decedent is considered to have an `incident of ownership' in an insurance policy on his life held in trust if under the terms of the policy, the decedent (either alone or in conjunction with another person or persons) has the power (as trustee or otherwise) to change the beneficial ownership in the policy or its proceeds, or the time or manner of enjoyment therof, even though the decedent has no beneficial interest in the trust. Moreover, assuming the decedent created the trust, such~a power may result in the inclusion in the decedent's gross estate under section 2036 or 2038 of other property transferred by the decedent to the trust if, for example, the decedent has the power to surrender the insurance policy and if the income otherwise used to pay premiums on the policy would become currently~ payable to a beneficiary of the trust in the event that the policy were surrendered." This regulation appears inconsistent with Treas. Meg. §20.2042-1(c) (2), which states that, although the term "incident of ownership" is not limited in its meaning to ownership of a policy in the technical legal sense, it generally refers "to the right of the insured or his estate to the economic benefits of the policy" [emphasis added]. Although subsection (c) clears up an uncertainty in a particular area, it does not attempt to define the term "incidents of ownership" because of the belief that such an attempt would lead to considerable litigation. The current regulations give sufficient general guidance as to the meaning of the term. Section 28 Transfer Taxes Paid on Transfers Other ~an At Death -181-. PAGENO="0265" 251 A In General This section requires the inclusion in an individual's transfers at death of the transfer taxes he paid with respect to certain lifetime transfers. Paragraph (1) prevents an individual from realizing transfer tax savings by making gifts shortly before his death. Paragraph (2) is required because of the credit allowed under Section 35 for taxes previously paid with respect to property transferred during life but included in the transfers at death pursuant to Section 21 - absent this paragraph, an individual would obtain the benefit of the credit against the tax imposed on his transfers at death without having the amount of such credit included in those transfers 3. Detailed Discussion I Paragraph (jJ The single rate structure of the Draft for transfers during life and at death makes it unnecessary to have transfers at death include a provision like section 2035, which requires the inclusion of transfers in contem- plation of death in an individual's gross estate. The purpose of that section is to prevent the undermining of the estate tax by transfers made shortly before death Never- theless, a tax benefit still exists for transfers subject to section 2035 because the gift tax on the transfer is ~ a credit against the estate tax under section 2012 and a deduction under section 2053 as a claim against the estate Paragraph (1) of Section 28 eliminates the tax advantage of a "contemplation of death" transfer by requiring that the transfer tax attributable thereto be included in the individual's transfers at death Unlike section 2035, the application of paragraph (1) is not dependent on the transferor's state of mind. Rather, it covers all transfers within two years of death. This approach will eliminate the frequent controversies on audit and the considerable litigation concerning the decedent's intent under the current provision In addition, any lingering constitutional question under Heiner~L Donnan, 285 U 5 312 (1932) arising from the use of a iumption as under current law should be foreclosed under paragraph (1) because intent is no longer relevant The two year period is of sufficient duration to include substantially all transfers that are truly made "in contemplation of death" The ALl Project (pages ~4-~47, 118-20) recommended a similar approach for a unified tax, but the time reference was to the two taxable periods -182- PAGENO="0266" 252 preceding the transferor's death. As the Reporter for the ALl Project concedes (pages 118), the length of time in a particular case could yary widely depending on when during the taxable period the individual died. This result is undesirable. The Studies (pages 361-62) do not contain a similar provision, because they would apply "grossing up" to all lifetime transfers (page 369) by providing for transfer tax purposes that a lifetime gift consists not only of the value of the property transferred but also the amount of the tax imposed on the gift. The Draft rejects "grossing-up" for lifetime transfers, but the effect of Section 28(1) is to impose this concept - a tax on the amount paid in tax - on transfers within the two year period. 2. Paragraph (2) This paragraph requires the inclusion in transfers at death of the amount of transfer taxes incurred at any time during an individual's life with respect to a transfer of property for which a credit is allowable under Section 35. It does not apply to transfer taxes included pursuant to paragraph (1). Section 21 will occasionally require the inclusion in an individual's transfers at death of property previously taxed as a result of a lifetime transfer by him. For example, assume A creates *a trust for his life and that of his wife, remainder to his issue. Under the trust, his wife has the power to direct distribution of the trust income amoung his descendants during her life; if she should predecease A, he is given the power to direct distribution of the trust income. A transfer tax will be payable upon the creation of the trust, since Section 13 will not be applicable - if A should die immediately after the transfer, he would possess no interest to which Section 21 applies, because his "springing" power would not then be in existence. If A does survive his wife Section 21 will be applicable, since he will at his death have a power over the income from the trust property. Section 35 will provide a credit with respect to the amount previously paid as transfer taxes on the same transfer. Section 28(2) brings the amount of the credit into A's transfers at death with the objective of achieving the same result as if the original lifetime transfer had been incomplete for transfer tax purposes until A's death. This approach does not, however, solve the problem of an increase in the calculation base upon which the taxon transfers at death will commence, because the trust property is included twice in A's transfers. It could be solved by a complex provision but, on balance, we believe the "simple" approach is preferable. -183- PAGENO="0267" 253 Section 29 Disbursements For the most part, Section 29 continues current law, but in a more simplified form. Two changes of substance, however, are proposed for section 205.3 as interpreted by the current regulations. They are: 1. Elimination of the requit~ement in Treas. Reg. §20 2053-3(d) (2) that expenses of sale are deductible only "if the sale is necessary in order to pay the decedent's debts, expenses of administration, or taxes, to preserve the estate, or to effect distribution"; and 2. Liberalization of the deduction for claims to encompass all claims, including certain claims not now deductible, against any property included in the decedent's transfers at death and transfers within 2 years of death that are paid, regardless of the time of payment As evidenced by the dissenting option in Estate~ David Smith,~ 57 T.C. 650 (1972), it is not entirely clear ~Eat the requirement of Treas. Reg. §20.2053-.3(d)(2) is a proper interpretation of current law More significantly, there is no logical reason tO prohibit a deduction for, expenses of sale Which are actually paid -- the amount of these expenses does not pass to any beneficiary of the estate. Fairness requires that all expenses of sale relating to property subjected to tax should be allowed as deductions. Under Section 29 such expenses incurred by a fiduciary - an executor or a trustee - will qualify for the deduction so long as the fiduciary had the power to make the sale The expenses of a sale by a non-fiduciary beneficiary will, however, be deductible only if the property sold was liable for ~a part of the death taxes or some other obligation of the estate. In expanding the deduction to include claims against any property included in the decedent's transfers at death or within two years of death, Section 29 eliminates section 2053(c)(2) which limits the allowable deduction to the amount of "property subject to claims" and amounts actually paid before the due date for the estate tax return "Property subject to claims" is defined as property In the gross estate (or the "avails" of such property) which would be charged with the payment of the deductible amounts This limitation is deleted The source of payment should be irrelevant so long as the payment is made from property subject to tax The time of payment should similarly be irrelevant because the estate is depleted by the amount disbursed in satisfaction of the claim whenever It is paid Amounts disbursed from property included In the -184- PAGENO="0268" 254 decedent's transfers within two years of his death are deductible under Section 29 because Section 28 of the Draft requires that the transfer tax paid on such amounts be included as part of his transfers at death, thus in effect treating these transfers as made at death. Amounts paid from such property prior to the individual's death will not be deductible. In place of section 2053(e), relating to marital rights, Section 29(a)(2) provides that amounts payable to a spouse under (1) a decree of divorce or separate maintenance, (2) a written instrument incident thereto, or (3) a written separation agreement will be deductible as claims against the estate, provided, as to (3) that the spouses lived apart continuously after the execution of the agreement. This subsection is consistent with Section 14 of the Draft, under which a transfer during life pursuant to such an arrangement is deemed made for an adequate and full consideration As to (1) and (2) current law is modified See Commissioner v Watson's Estate, 216 F 2d 9~41 (2d Cir 19511) The language of the subsection is taken from a recommendation of the American Bar Association, Tax Section (Report of the Committee on Domestic Relations Tax Problems, Bulletin of the Section of Taxation, American Bar Association vol XIX no 14, at 66-68 (1966)) Section 29 continues the requirement of section 2053(c)(1)(A) that a claim founded on a promise or agreement be contracted bona fide `for an adequate and full consideration in money or money's worth " The rule for charitable pledges in the current subparagraph in continued in simplified form in Section 29(a) -- a pledged amount will be deductible to the extent that a bequest of the amount in the form pledged would be a charitable contribution under Section 31. The present general treatment of expenses paid from community property included in transfers at death is continued under Section 29. Recently several community property states have altered their law to make funeral expenses chargeable in full to the decedent's share of community property The Service has acknowledged this result on a state-by-state basis. ~ Rev, Rul. 71-168, 1971-1 Cum. Bull, 271; Rev. Rul. 69~T93, 1969-1 Cum. Bull. 222 Since the Service has indicated its willingness to be guided by state law in this area, no special provision in Section 29 is necessary The approach of Section 29 eliminates the need for parts of section 2053 Section 2053(a)(i1), referr~.ng to unpaid mortgages and indebtedness, has been omitted as unnecessary -- these amounts are included as claims against -185- PAGENO="0269" 255 property included in transfers at death Section 29 also renders unnecessary the current divergent treatment under Treas Reg §20 2053-7 of mortgages involving estate liability for payment and mortgages where such liability is not present in the latter case, the value of the mortgaged property is "currently netted" and only the equity of redemption or the value of the property less the mortgage amount is included in the decedent's estate In addition, it is not necessary to state in the statute that a mortgage or indebtedness cannot act both to reduce the value of the affected assets in determining the amount includible and also to lessen the amount subject to tax by way of a deduction under Section 29; this is obvious and can appropriately be handled in the regulations Similarly, the section deletes as unnecessary the references in section 2053(c)(1)(B) to income taxes on income received after the decedent's death or property taxes not yet accrued at that time. The provisions were inserted in order to clarify the section (H.R. Rep. No. 767, 65th Cong. 1st Sess. at 22; H.R. Rep. No. 708, 72nd Cong. 1st Sess. at ~8; S. Rep. No. 665, 72nd Cong. 1st Sess. at 51) and the non-deductibility of these items is no longer open to question. The remainder of section 2053(c)(1)(b), relating to estate, succession, legacy or inheritance taxes, is combined with subsection (d) of that section Subsection (d) allowing a deduction for such taxes where they constitute a state or foreign levy on property passing to charity and. the amounts paid as tax would otherwise be received by the charity, is rarely used, and can better be continued in the simplified form set out in Section 29(b), leaving further detail to the regulations. The ALl Project did not propose changes to section 205.3. The Studies (at 382-83) propose that certain items, which now constitute section 691 (b) deductions, and are therefore deductible for both estate tax and income tax purposes, be deductible only for income tax purposes and that the executor's election to claim administration expenses as either income tax or estate tax deductions be eliminated. The Draft rejects each of these proposals. The change in the treatment of the section 691(b) deductions is predicated upon the elimination of income in respect of a ctecedent (section 691 income) recommended in the Studies under its capital gains tax at death proposal Since the Draft continues the current tax treatment of section 691 income by excluding such income from the AET the law as to the section 691(b) deductions which is logically sound should also remain the same -186- PAGENO="0270" 256 The reason given for eliminating the election to claim administration expenses as either income tax or estate tax deductions is: "The proposal would attempt to eliminate the problems which have arisen because of the election under which the executor has to take certain expenses as deductions either against estate income or against the gross estate. This option often places the executor in a conflict of interest position between the interests of the income bene-ficiaries and the remaindermen, or between the surviving spouse taking property under the marital deduction and the residuary legatees. This option also produces structural dislocations in that estate income is reduced by deductions which have no relation to the production of that income." (Studies, page 383) The Studies overstate, and to some extent misrepresent, the "problem" of the executor. Under existing law the executor is required, by case law or statute, to charge to income (and credit to principal), to the extent income is benefited, the amount by which the estate taxes are increased as a result of claiming administration expenses chargeable to principal as income tax deductions. See Matter of Warms, 1~4O LY.S.2d 169 (1955), codified in New York Estates, Powers and Trusts Law 11-1.2(a); Inre Bix~y's Estate, 295 P.2d 68 (Cal. App. 1956); In re Bell's Estate, 7 Fiduciary Report 1 (Pa. 1956); In re Veith's Estate, 26 Fla. Supp. 145 (1965); Md. Ann. Code, art. 93 §11-106(a). Thus, except in connection with the available marital deduction, there is no conflict of interest. More importantly, the Studies proposal would discriminate against the small or medium size estate where the administration expenses (which must be paid) will be of no benefit in reducing the transfer tax at death because the estate owes no tax. The references in the Studies to "structural dislocations" and "relation to the production of income" are puzzling. Section 212 is not limited in scope to expenses for the production of income. Section 212(2) grants a deduction for expenses "for the management, conservation, or maintenance of property held for the production of income" and has been a part of the income tax law for a long time. It is hard to see why a particular type of expense, which clearly fall within section 212(2), should be singled out for separate treatment merely because the same amount is deductible under Section 2053. Seetlon ~. Pronertv Previously -187- PAGENO="0271" 257 Section 33 allows a deduction for property included in an individual's transfers at death which was subjected to a transfer tax within the 10 years preceding his death It replaces section 2013, which contains a more complicated credit approach to the same problem. Without some adjustment for recently taxe.d property, it would be taxed twice within a limited period of time solely by reason of the death of the recipient, a non-volitional event. The ALl Project sets forth the case for such an adjustment in stating: "When property is subjected to transfer taxation it is only fair that it not be pushedthrough the transfer tax mill again for some reasonable period of time by the death of the recipient, an event over which the recipient has.no control (page 23)." This conclusion is not accepted in the Studies, which take the position that an adjustment for property previously taxed should be eliminated It is alleged that the situation causing most concern is where spouses die within a short time of each other, and that an unlimited marital deduction would eliminate unfairness through an exemption from tax at the death of the first to die. The Studies regard all other situations in which previously taxed property will be taxed again as "patterns of disposition which [do not) warrant special relief" (page 371). The Studies, in reality, ignore with this conclusory pronouncement the issue of how often it is appropriate to subject property to transfer taxation and it is in fact inconsistent with the basic thrust of the Studies, which is that a transfer tax should be imposed once each generation (page 388). The situations which the Studies believe do not warrant relief comprise many common and ordinary dispositions to the natural objects of an individual's bounty, such as transfers between brothers and sisters. The appropriate reference point is the time which has elapsed between the transfers which give rise to the two taxes - unfairness results from the fact that the recipient's death, an unpredictable and uncontrollable event, triggers a second transfer tax close on the heels of the first Further the Draft does not contain an unlimited marital deduction; some relief is clearly necessary for transfers between spouses where they die close in point of time. Section 33 is based upon a recommendation of the ALl Project (pages 23-26, 162-63). The section allows a full deduction for property previously taxed which was -188- PAGENO="0272" 258 transferred to the individual within six years of his death The deductible amount must be reduced by 20% for each additional year or part of a year which elapsed between the prior transfer andthe individual's death. The value of the property which is the subject of the deduction is to be determined as of the date of the prior transfer. As under current law (see Treas.. Regs. §20.2013-1(a)), the transferred property need not be identified in the recipient's transfers at death or be in existence at his death for the Section 33 deduction to be available. Section 33 departs from current law in several important respects They are (1) the use of a deduction rather than a credit approach (2) the broadening of the adjustment to cover property previously taxed by reason of a lifetime transfer; (3) the disallowance of an adjustment for a beneficial interest in a trust or its equivalent that is not included in the recipient's transfers at death; and (~) the deletion of the section 2013 provision which allows an adjustment when the transferor dies no more than 2 years after the recipient. Each of these changes will be discussed separately 1. The deduction approach is consistent with the theory of the adjustment that the same property should not be subjected to taxation twice within a limited period. In contrast with the credit approach of section 201.3, it removes the property from the individual's taxable transfers, and thus bears no relationship to the rate at which the property was taxed at the time of the first transfer. The deduction approach will also simplify the calculations necessary *to determine the amount of the adj us tment. 2. The Section 33 deduction is available whether the prior transfer occurred during the transferor's life or at his death. Under a single transfer tax rate structure, there is no reason to limit the deduction to property previously transferred by reason of death. It is the absence of volition in the second transfer which generates the unfairness in a second tax 3. Section 2013(e) and Treas. Reg. §20.2013-5(a) permit a credit for the value of a life estate or income interest where the underlying property is not included in the beneficiary's gross estate. This reflects the "depletion" theory rationale: by reason of the interest, the beneficiary was not forced to expend other of his assets for his support; since those other assets are included in his gross estate, an adjustment is proper for the beneficial interest which brought about their taxation at death. While this theory is logically sound, its application is troublesome. -189- PAGENO="0273" 259 The value of an income interest is determined actuarially (see Treas. Regs. ~20.2031-1O) as of the transferor's death and may be considerably different from what the beneficiary actually receives. Also, the actuarial value is based upon an assumed return of 6% per year, a rate which significantly overstates the actual returr which most income beneficiaries receive. The depletion concept could be retained in Section 33 with a more satisfactory result if the value to be placed on the interest reflected the actual amounts received by the beneficiary with an appropriate discount. It is only to the extent of such amounts that the beneficiary's other assets are preserved. However, such an approach would involve complexity and produce tracing problems. Section 33 takes the position that no deduction for a trust interest should be permitted unless the underlying property was paid to the beneficiary or is included in the beneficiary's transfers at death. This approach eliminates the problem of, and inaccuracies involved in, valuing such an interest and results in a much simpler provision. 4* No deduction is permitted for property taxed by reason of a transfer after the recipient's death. Section 2013 permits a credit if the original transferor dies within two years after the recipient's death, in order to avoid in nost instances a tax in the recipient's estate where the property is included thereafter in the transferor's estate under the contemplation of death rules of section 2035. 5. Rep. No. 1622, 83d Cong., 2d Sess. (195J4). The change made in current law that is discussed in 2 above makes it unnecessary to provide for this contingency because all lifetime transfers will be eligible for the Section 33 deduction. Section 35. Credit for Transfer Taxes Previously Paid. Section 35 provides a credit against the Section 1 tax imposed on transfers at death in the amount of any tax paid on an inter vivos transfer of property which is taxed again at th~ransferor's death by reason of Section 21. The section is related to Sections 9, 13 and 21 and the approach embodied therein for the taxation of a lifetime transfer where less than all of the transferor's interests in the property are conveyed. See the discussion of those sections, and examples (3), (5), (9) and (11). Unless the transferor retains an interest in / "gift" property requiring the property to be taxed in his -190- 68-872 0 - 76 - 18 PAGENO="0274" 260 transfers at death upon his immediate death under Section 21, the entire value of the lifetime transfer will be taxed when made. If a retained interest a "springing" right or power - arises and is in existence at the transferor's death, all or a part of the property will also be includible in his deathtime transfers. Under Section 28, the amount of the lifetime transfer tax on the property is brought back into the transfers at death. Thus, the Section 1 tax is computed on the full amount included under Sections 21 and 28. Section 35 avoids the imposition of a second transfer tax on the same property. The Section 35 credit is available only where (1) between the original transfer and the death of the transferor, the underlying property has not been included in any other person's transfers, either lifetime or at death, and(2) the transferred property is included in transfers at death under Section 21. Where the property is brought into the transferor's transfers at death under a section other than Section 21, the inclusion will not be by reason of the original inter vivos transfer previously taxed. Also, difficult tracing problems would be presented by broadening the credit to other situations. The Section 35 credit bears no relationship to the relative values of the transferred property at the time of the original transfer and at the time of the transferor's death. When the property increases in value, there is obviously no reason to require any reduction in the credit. However, when the property decreases in value it may be contended that the credit should be adjusted downward to reflect the decrease. Section 35 does not do so in the interest of simplicity and fairness - the transferor has been penalized by the double inclusion under one.rate schedule and the "early" payment of the transfer tax at the time of the original transfer. Section 14~* ADportionment of Taxes. A. In General This section establishes in specified instances a normally operative rule that a part of the transfer tax be apportioned to and paid from the property to which such tax is attributable. This rule will yield to a contrary direction in the decedent's will. Section ~4 is divided into two subsections - subsection (a) relates to the apportionment of the Section 1 tax, while subsection (b) provides for an apportionment of the -191- PAGENO="0275" AET under Section 2 It does not apply to the Section 1 tax on lifetime transfers Section 8 does, however, contain an apportionment provision which applies where a transfer under that section is included in an individual's taxable transfers during a calendar quarter. B. Detaile4 Discussi~~~ 1. Subsection (aj Subsection (a) involves apportionment of the Section 1 tax where property is included in the decedentts transfers at death under Section 22, 25, 26, 27 or 28. a. Paragraph kt) Paragraph (1) `applies in two situations where property over which the decedent has no control to direct payment of the tax is includible in. his transfers at death, viz., where property is included under Section 25, relating to the termination of a beneficial interest in a trust or its equivalent, or under Section 27, relating to property for which a marital deduction was allowed. The paragraph requires that a part of the Section 1 tax be apportioned to such property equal to a tax on it at the highest (marginal) rates applicable to the decedent's transfers. This paragraph is intended to protect an individual's "free" assets at death from the effect of inclusion of property under Section 25 or 27, an inclusion which will result in higher marginal and average rates being applied under Section 1 to the decedent's transfers. Because the individual had no control over the included property, the normally operative rule should be to prevent any part of the increased tax resulting therfrom from being charged to his other property included in taxable transfers at death. The individual may, of course, direct a different apportionment through an appropriate clause in his will. If paragraph (1) and another paragraph of this subsection are applicable, apportionment is to be made under this paragraph first. The amount of the tax apportioned under paragraph (1) and the property against which it is charged are then subtracted in determining any apportionment under another applicable paragraph. The ALl Project (page 89) and the Studies (page 378) propose the same approach to apportionment with respect to property which is not subject to control by a person having such property included in his transfers at death. b ~~~~raph (I) Paragraph (2) applies to property included in an -192- 261 PAGENO="0276" 262 individual's taxable transfers under Section 22, relating to property subject to a general power of appointment, or Section 26, relating to insurance proceeds on his life received by a person other than the executor. The apportionment under this paragraph is made at the average rate of tax applicable to the individual's deathtime transfers rather than at the highest marginal rates applicable thereto. It continues sections 2206 and 2207 and requires that there be paid from the property an amount of the Section 1 tax which is in the same proportion to the total Section 1 tax as the value of the included property bears to the decedent's total taxable transfers at death If an apportionment under paragraph (1) is also involved, both the Section 1 tax and total transfers are reduced by the amounts to which that paragraph relates. c. Paragraph (3.) This paragraph applies where an amount which the decedent paid as transfer taxes upon an inter vivos transfer is included in his transfers at death under Section 28. An apportionment provision is necessary because the amount included is no longer on hand it has been paid to the government and cannot be reached as a souroe of the tax payable due to its inclusion. It is impossible to discern what the "average" transferor's intent might be in this situation - whether he would place the tax burden on the inter vivos disposition or on his testamentary estate This paragraph apportions the tax against the inter vivos property, and operates in the sane way as paragraph (2) A transferor who wishes a different allocation is free to direct it by an affirmative provision in his will. 2 Subsection (b) This subsection provides for an apportionment of the AET, where property containing unrealized appreciation isreceived by a person other than the executor. It bases the apportionment on the ratio of the net appreciation in the property not received by the executor to the total net appreciation in the transfers taxed under the AET, rather than upon the taxable transfers at death, because there are no deductions allowed in computing the AET. Since the Section 2 tax is not a graduated tax, the apportionment under subsection (b) does not require reference to the progressive transfer tax rates applicable under Section 1. -193- PAGENO="0277" Recommendations Concerning Payment of the Transfer Tax The "Liquidity Problem." A Introduction The Studies contain a section captioned "Liber- alization of Payment Rules". The opening two paragraphs of the section accurately state "Estates which contain farms or closely held family businesses sometimes encounter difficulty in finding the cash needed to pay the Federal taxes which become due shortly after death. This problem can arise as a result of improper estate planning rapid appreciation in the value of an asset, or reluctance to sell an asset for sentimental or business reasons The inability to pay death taxes in a timely fashion is here referred to as the `liquidity problem' Careful business and estate planning can help to eliminate the liquidity problem. Moreover, the Internal Revenue Code already provides installment payment privileges for use in situations in which an estate contains a farm or other closely held business. However, experience has shown that little use of these installment payment privileges is presently being made, partly because certain other provisions of the Internal Revenue Code create barriers to the use of these privileges " (Studies, page 1101) The "liquidity problem" will obviously be more serious than it is under existing law if there is a change in the current basis rule, unless the change is accompanied by a reduction in transfer tax rates, such as that proposed in Section 1 of the Draft. The ALl Project did not deal with the liquidity problem. Current law recognizes that the payment of the entire tax on the due date - nine months after the decedent's death - may, in certain circumstances be difficult or impossible if certain conditions are met, a delay is permitted in payment of the tax and in some cases a lower 14% interest rate is available on the unpaid balance in lieu of the normal 6% rate These liquidity" provisions are contained in sections 6161 6163 6165 6166 and 6601 of the Code In addition section 303 establishes a special income tax rule that if certain conditions are met payments made in redemption of stock included in a decedent's gross estate are entitled to capital gain treatment in an amount not to exceed the estate's death taxes and the funeral and administration expenses Since the liquidity problem as it 263 -194- PAGENO="0278" 264 now arises involves the interplay of these provisions, each will be discussed separately, with the Studies' proposals and our comments. A matter related to the liquidity problem is the executor's personal liability for the tax as to which the time of payment has been extended. This liability continues unless that of a bonding company is substituted, in which event the cost of the bond adds to the liquidity problem. B. Section 6601(b). This section states that if the time for payment of estate tax is extended under section 6161(a)(2), section 6163 or section 6166, interest is payable at a 14% rate rather than at the usual 6% rate. In suggesting a change in section 6601(b), the Studies state (page 1407-08): "To achieve interest neutrality so far as decisions regarding payment of taxes are concerned, a provision is proposed, similar to section 1483, giving the Secretary or his delegate discretionary authority to establish the rate of interest at any given time in light of market conditions. To facilitate this exercise of discretion, and to ease administrative difficulties, the following guidelines for the exercise of this power would be followed: (1) The rate of interest should be adjusted only on January 1 of any given year, and should remain constant throughout that year. (2) Adjustments to interest rates should be made in whole point units, rather than, in fractions of a percent. (3) Adjustments should be made in ~light of market conditions, determined by adding 2 percentage points to the Federal Reserve System's recommehded rediscount rate. (14) The rate of interest applicable on the date on which a tax becomes payable will remain the same for that tax liability until it is paid. For example, if a tax becomes payable on December 31 of a given year, when the rate of interest under section 6601 is 5 percent, the rate of interest will remain applicable even though the interest rate is raised a few days later by the Commissioner." The change suggested in the interest rate, from 14% to a rate of 2% higher than the Federal Revenue System's recommended rediscount rate*, will under current conditions * [Footnote on next page] -195- PAGENO="0279" 265 and conditions that are now forseeable for the future increase the interest payable when extensions of time to pay the tax are obtained to a rate higher than the normal 6% rate We share the Studies' concern with respect to granting a preference in the form of a Lt% interest rate when extensions are granted under section 6161(a)(2), section 6163 or section 6166. The preferential rate is undesirable for two reasons. First, it is applicable to extensions under some provisions but not to extensions under other provisions. Second, and more important, the effect of the preference is to make liberalization of the liquidity provisions more difficult. Liberal payment rules are appropriate if a preferential rate is not included We recommend elimination of the ~pecial ~% rate and a return to the normal 6% rate in all eases. Our support for this change is subject to the dondition that the other liberalizing changes suggested herein are made. C. Section 6j~5. This section provides that if an extension of time is granted to pay any part of the estate tax, the taxpayer may be required to furnish a bond (in an amount not to exceed double the amount as to which an extension is granted) conditioned upon the payment of the extended amount. The Studies would revise this section to permit the use of security arrangements, such as mortgages, pledges and escrow agreements, in lieu of bonds. The exact form of the security arrangements would be left to the District Director. When determining the amount of the collateral to secure the payment of taxes where an extension is granted under section 616.6, section 6165 would provide that the decedent's interest in a closely held business shall consti- tute adequate collateral * [Footnote from preceding page] The rediscount rate has now been eliminated in favor of a single "discount rate' This rate recently raised from 5% to 5 1/27 is fixed by each Federal Reserve Bank subject to approval by the Board of Governors of the Federal Reserve System. In practice, the rate has been administered as a single uniform nationwide rate, but it may be several days before a change in the rate beoomes effective in all 12 Federal Reserve Districts -196- PAGENO="0280" 266 We favor the use of security arrangements rather than bonds and permitting the decedent's interest in a closely held business to constitute adequate collateral These arrangements should, to the extent feasible, be "standardized" through regulations to avoid variances among District Directors with regard to their use D. Section 6166. This section permits the time for paying estate taxes to be extended automatically for a period not to exceed 10 years if the value of an interest in a closely held business included in the decedent's gross estate exceeds either 35% of his gross estate or 50% of his taxable estate. The part of the tax as to which an extension is available is the same percentage of the net estate tax payable as the value of the closely held business bears to the gross estate The words "closely held business" are defined to mean a. An interest as a proprietor in a trade or business carried on as a proprietorship. b An interest as a partner in a partnership carrying on a trade or business if (i) 20% or more of the total capital of the partnership is included in the gross estate or (ii) the partnership has ten or less partners. c. Stock of a corporation carrying on a trade or business if (i) 20% or more in value of the voting stock is included in the gross estate or (ii) the corporation has ten or less shareholders The amount of the tax as to which payment is extended plus interest is to be paid in equal annual installments The Studies propose to liberalize this section by (i) changing the percentage limitation to 25% of the decedent's taxable estate, (ii) eliminating the requirement that the stock be voting stock, (iii) increasing the shareholder limit to 15, and (iv) broadening the section to cover gains taxed at death if the gains attributable to the closely held business are more than 25% of all gains taxed at death. Section 6166 would be tightened by shifting from annual to quarterly installment payments. The stated reason for shifting to quarterly installments is "This conforms with existing collection practice in connection with estimated taxes and certain other taxes which are paid in installments. This change will also -197- PAGENO="0281" 267 provide earlier notice of possible delinquency on the part of the estate " We believe that increasing the interest rate from L~% to 6% on tax payments deferred under section 6166 justifies more liberalization in the requirements for section 6166 to apply than is contained in the Studies proposal, bearing in nind that the deferral is available only for the pro rata part of the taxes attributable to the interest in the closely held business. We support the increase in the nunber of pernissible stockholders and the reduction in the percentage limitation, but the reduction should be to 20% of the decedent's taxable estate, a percentage more than sufficient to generate a liquidity problem in most estates If a partnership carrying on a trade or business is involved, the percentage should be reduced from 20 to 10 and the "number" limitation should be increased from 10 to 20 The primary difficulty with the position taken in the Studies is that it fails to recognize that the liquidity problem may also arise from the lack of a market for the stock. Section 6166 should be available whenever the percentage limitation - 20% of the decedent's taxable estate - is met and (i) the stock is not traded on a national securities exchange or in the over-the-counter market or (ii), if so traded, the decedent's transfers at death include 20% or more of the stock of the corporation Requirement (i) is substantially the sane as that suggested by the Administration in determining whether a stock is a "liquid asset" in its original 1970 proposal for accelerating the payment of estate tax We oppose quarterly rather than annual install- ment payments Such an acceleration would increase the liquidity problem and be more burdensome administratively. The reasons suggested in the Studies for this change are unconvincing. The AET should be considered as a part of the Section 1 tax for the purpose of applying section 6166. E Section 303 This section provides that a distribution of prop- erty to a shareholder in redemption of stock is entitled to capital gains treatment to the extent that the amount of the distribution does not exceed all death taxes imposed as a result of the decedent's death and all funeral and administration expenses of the decedent's estate if the entire stockholding included in the decedent's gross estate exceeds 35% of the gross estate or 50% of the taxable estate. -198- PAGENO="0282" 268 The Studies propose to revise this section by (i) permitting redemptions to extend over a 10 year period, but not to allow the use of notes or the like to avoid the time limitation, and (ii) restricting its application to those persons liable for the payment of the federal estate tax or the tax on capital gains at death with respect to closely held businesses as defined in section 6166 (thus automatically applying the qualifications set fO~'t~h in that~ section) but not permitting a "qualified" redemption for state death taxes or funeral and administration exp~nses We favor conforming the requirements of section 303 to those of section 6166, extending the redemption period to 10 years and broadening the section so ~as to cover the AET attributable to the redeemed stock We also favor the insertion of a limitation that section 303 may be utilized only to the extent the redeeming shareholder is liable for the payment of death taxes or funeral and administration expenses. The payment of state death taxes and funeral and administration expenses is a part of the liquidity problem. Thus the proposal that redemptions for these purposcs be eliminated worsens rather than lessens that problem. We oppose such a change. The Studies give no reason for this elimination Lastly, we support the suggestion made by others that section 303(b)(2)(B) be broadened to base calculation of the ownership percentages required where two or more businesses are involved upon the constructive ownership rules of section 318. This would bring section 303 in line with the rules applicable in the comparable redemptions under section 302, and would reverse case law, such as Estate of~yrd V. Commissioner, 388 F.2d 223 (5th Cir., 1967), requiring direct ownership of stock by the redeeming party F. Section 6161. This section permits the time for paying estate taxes to be extended for "a reasonable period not in excess of 10 years" if payment of any part of the tax would result in "undue hardship to the estate". Treas. Regs. §20.6161-1(a)(2)(ii), relating to the hardship requirement, says "The extension . . . will not be granted upon a general statement of hardship or merely upon a showing of reasonable cause, The term `undue hardship' means more than an inconvenience to the estate. A sale of property at a price equal to its current fair market value, where a market exists, is not ordinarily -199- PAGENO="0283" 269 considered as resulting in an undue hardship to the estate The Studies propose no change in this section, except to have it apply to unrealized appreciation taxed at death, the AET under the Draft. In the light of our proposal to use an interest rate of 6% for all deferrals of the payment of estate taxes, the word ~ be eliminated from section 6161(a)(2) so that an extension would be granted upon a showing of "hardship" as contrasted to "undue hardship". It is most difficult to split hairs between what is "hardship" and what is "undue hardship". G. Section 6163(a). This section states that the payment of the part of the tax attributable to the value of a reversionary or remainder interest inproperty included in a decedent's gross estate may, if the executor elects, be postponed until six months after the termination of the preceding interest. Treas. Regs. §20.6163-1(c) provides that the tax attribu- table to the reversionary or remainder interest is an amount which bears the same ratio to the total tax as the value of the interest bears to the gross estate. The Studies propose no change in this section. Section 6163(a) should be broadened to include any asset the receipt of which is delayed for a period of at least 15 months after the decedent's death, as well as a reversionary or remainder interest, so that the executor could elect to postpone the payment of the estate tax attributable to such asset until six months after its receipt. To illustrate, if a decedent's est~te has a right to receive a payment of $10,000 in each Of five years after his death the tax attributable to each of the last four payments could be postponed until after the payment was received. The policy considerations that led to the enactment of section 6163 are equally applicable to this type of case. H. Section 22014. This section is related to the liquidity sections because the fiduciary remains personally liable for taxes whose payment has been postponed. The continuing personal liability of fiduciaries has severely restricted the use of section 6166. Section 22014 relieves the executor from personal liability when the full amount of the estate tax determined to be due has been paid Without the use of a bond, a discharge cannot be obtained when an extension of time to pay the tax has been secured because the tax has not been paid. -200- PAGENO="0284" 270 Section 220L1 should be revised to permit the discharge of an executor from personal liability when (i) the executor has paid all taxes assessed prior to the date of the discharge and for which no extension has been requested and (ii) the executor enters into a section 6165 security arrangement. Also, similar rules should be applied to other fiduciaries holding assets includible in the gross estate - if the fiduciary applies for a discharge from personal liability and the executor fulfills the two conditions set forth in the preceding sentence, the discharge should be available to such fiduciaries. -201- PAGENO="0285" 271 Cross-Reference Tables I. Location of Current Provisions in the Draft Current Section Draft Estate Tax 2001 1 2022 37 2011 35 2012 34 2013 33 2014 36 2015 37 2016 38 2031(a) 17 (b) - 2032 18 2033 19 2034 20 2035 1(c) (2) 2036 21 2037 - 2038 21 2039 23 2040 24 -202- PAGENO="0286" 272 Current Section Draft 2041 22 2042 26 2043(a) 17 (b) - 2044 2051 17 2052 34 2053 29 2054 30 2055 31 2056 32 2101 - 2108 - 2201 46 2202 43 2203 39 2204 40 2205 41 2206 42 2207 42 2208 44 2209 45 -203- PAGENO="0287" 273 Current Section Draft Gift Tax 2501(a) (1) 1 (2)-(4) - (b) 44 (c) 45 2502(-~1 1 (b)-(c) - - (d) 37 2503(a) 3 (b)-(c) 11 2504 - 2511 - 2512 (a) - (b) 3 2513 5 2514 7 2515 6 2516 2517 - 2521 12 2522 14 2523 15 2524 - -204- PAGENO="0288" 274 ii. Provisions not continued in Draft - Estate Tax 2031(b) Valuation of unlisted stock and securities 2037 Transfers taking effect at death 2043(b) Marital rights not treated as consideration 2044 Prior Interests 2101-2108 Estates of nonresidents not citizens Gift Tax 2501(a) (2)- Relating to aliens and (4) expatriates 2502(b)-(c) Definitions relating to calen- dar years and quarters 2504 Taxable gifts for preceding years and quarters 2511 Transfers in general 2512 (a) Valuation of gifts 2517 Certain annuities under qualified plans 2524 Extent of deductions -205- PAGENO="0289" 275 American Bankers Association Corn rnentary on Proposed Tax Reform Affecting Estates and Trusts AMERICAN BANKERS ASSOCIATION 1120 ConnectIcut Avenue, NW. WashIngton, D.C. 20036 68-872 0 - 76 - 19 PAGENO="0290" 276 TABLE OF CONTENTS Foreword Summary of Exemptions; Level of Taxation, Farm and Closely Held Businesses Commentary 1 Suannary of Basis Commentary 3 Summary of Unification Commentary 6 Summary of Marital Deduction Commentary 7 Exemptions, Level of Taxation Farms and Closely Held Businesses 8 Basis 15 Generation-Skipping 19 Unification 23 Marital Deduction 26 Appendix A 28 * Copyright© 1972, 1976 American Bankers Association All Rights Reserved PAGENO="0291" During recent years the laws governing the income tax cost basis of a decedent's assets and various provisions of the estate and gift tax laws, all of which have been essentially unchanged for many years, have been criticized. Two comprehensive proposals for change have been the 1968 Treasury Studies during the Johnson Administration and the American Law Institute Project published in 1968. The most recent criticism has been directed at what is regarded as the modest $60,000 estate tax exemption and high estate tax rates which may force the sale by the decedent's family of a farm or closely held business. The so-called liquidity problem was accentuated by the increase in 1975 of the 4% interest rate applicable to estate tax on farms and closely held business. Since early 1970 the American Bankers Association (the ABA) has been study- ing changes. In 1972 ABA published a Commentary reviewing current law, some major proposals for change, evaluation of these proposals, and alternatives. This Commentary modifies in some respects and expands the 1972 publication. 277 FOREWORD PAGENO="0292" 278 SUMMARY OP EXEMPTIONS; LEVEL OF TAXATION; FARMS AND CLOSELY HELD BUSINESSES COMMENTARY Current Law Since 1942 the estate and gift tax exemptions of $60,000 and $30,000, re- spectively, and estate and gift tax rates have remained the same. The estate tax rates progress rapidly in the lower brackets reaching 30/ at a taxable estate of $100,000. The result has.been that over this 34 year period, with continuing inflation the estate tax has ceased tocbe a rich man's tax and now has a significant impact on estates of the middle class. The tax causes particular, hardship for estates with farms and closely held businesses and in a significant percentage of cases requires their sale even though family members would like to continue their operation This result has been criticized with increasing frequency in recent years. Major Proposals for Chang~e Estate tax relief has been proposed in either of two ways or a combination of both 1 Increase the estate tax exemption to a figure in the range of $100 000 to $200 000 - 2 Limit relief to estates with farms and closely held businesses which under current law are eligible to pay estate tax in ten annual installments The Administration has recently proposed a five year moratorium on the payment of estate taxes on certain farms and closely held businesses No interest would be paid during the five year period. The payment pe4od . would be extended from the current 10 year period to 20 years after the end of the moratorium. The special 4/ interest rate on deferred estate tax which was increased last year would be reinstated. Eligibility would be limited to $300,000 of assets, with a dollar for dollar reduction from $300,000 to $600,000. ABA Evaluation An increase in the estate tax exemption tO a figure in the range of $100,000 to $200,000 would substantially decrease estate tax revenues. The revenue loss from giving relief only to estates with farms and closely held businesses would be much smaller. The Administration's proposal is question- able in a number of respects. A moratorium, which amounts to a five year interest free loan on the amount of the deferred estate tax seems unnecessary and will encourage the continued operation of farms and. closely held businesses which cannot survive economically. An additional 20 year paymentS period is not needed and would raise additional complications when one or more of the heirs receiving the property dies during this period. A dollar for dOllar decrease in eligibility between $300,000 and $600,000 seems too rapid and will operate inequitably when compared-with some cases where the asset has a value under $300,000. 1 PAGENO="0293" 279 ABA Alternative An increase in the $60 000 exemption should not be considered in a vacuum but rather as a part of the issue whether estate and gift tax revenues should be increased, decreased or held at approximately the same level. The ABA assumes that the current level of estate and gift tax will not be significantly decreased. Based upon this assumption, it believes that the $30,000 gift tax exemption should be retained, but that the estate tax exemption should be increased to $70,000 ~ that part of the gift tax exemption which is not used during life. The ABA favors changing the exemption from a deduction, which may be claimed against a decedent's highest estate tax rates, to a credit against the tax at the lowest estate tax rates. This change will minimize the revenue loss from the estate tax exemption increase. The ABA favors relief for farms and closely held businesses. In order to assure that relief is given only in deserving cases three additional require- ments to the ones that now exist to qualify for the ten year installment payment provisions should be imposed, namely, that the farm or closely held business be at least 65% of the decedent's adjusted gross estate, that it be owned by the decedent for at least two years priOr to his death and that the heirs continue in the business as "operators" rather than as "investors". If these require- ments are met, the interest rate on the estate tax installment payments would be reduced to 4% and a part of the installment payments of tax and interest would be forgiven. The forgiveness would be 10% of the first installment and would increase by 5% for each succeeding installment until it is 55% for the tenth installment. If the value of the farm or closely held business exceeds $400,000, the forgiveness percentages would be appropriately reduced. The ABA recommends other changes which will increase the usefulness of the installment payment provisions 2 PAGENO="0294" 280 SUMMARY OP BASIS COMMENTARY Current Law Current law providing a step-up of income tax cost bases of a decedent's assets to their market values at death has been criticized for allowing a permanent escape from income tax on appreciation which encourages investment retention or "lock-in." Major Proposals for Change 1. Retain step-up in basis but levy a capital gains tax on appreciation at death; assess as part of the decedent' s final income tax return; and allow the tax paid as a deduction in computing the estate tax. Usually only apprecia- tion beyond a current valuation start-up date would be taxed under this type of proposal. 2. End step-up and -carryover the decedent's bases for estate assets, but increase these bases by the estate tax attributable to the asset's appreciation element. ABA Evaluation The capital gains'tax proposal is undesirable because its estate tax * deductibility would result in a proportionately lower combined tax on apprecia- tion in larger estates than in smaller estates The carryover basis proposal is objectionable because of its administrative complexity in allocating basis increases; its unfairness in giving basis increases to assets which occasioned *no estate tax because they qualified for the marital or charitable deduction; and the lesser hope it offers for reduced estate tax rates. Both proposals would further, complicate the administration of estates and increase the "cost of dying" which is high enough now. ABA Alternative As an alternative, the ABA recommends an additio~ial (or appreciation) estate tax (AET), which would be a flat rate tax reported in the estate tax return but have a separate and equivalent exemption c~currently $60,000). Sinc~ the AET would not be a deduction against the estate tax, its tax effect would not be regressive. It also would be the simplest approach administratively. The AET rate would be set so that the tax paid would be the same as the largest estates would pay under the capital gains tax proposal while smaller estates would pay less. Because the ABA considers the current "cost of dying," including -. state taxes, high enough, the ABA suggestion of an AET is conditioned upon both (1), ~a new cost basis valuation date for all assets in computing the AET, and (2) a reduction in estate taxes comparable to the projected AET collections. 3 PAGENO="0295" 281 Thus, the AET would permit lower estate taxes on all estates, and reduce the "cost of dying" for those estates, usually smaller in size, which contain few appreciated assets. 4 PAGENO="0296" 282 SUMMARY OF GENERATION-SKIPPING COMMENTARY Current Law Current law imposes a tax on the transfer of complete control over proper- ty, but a shift of interests in property without such a change in control is not a taxable event. A trust embodying a succession of interests lacking the control element may be insulated from estate or gift tax for 100 years or more. To thwart this tax delay, the theory is espoused that all property should be subject to estate tax every generation, and that trusts which do not create taxable in- terests in the next generation should bear an added tax burden. Major Proposals for Change The 1968 Treasury Studies would assess a tax at 60% of the transferor's top rate on any transfer made outright or from a trust tcra~~~~EflofiB!'êmote descendant. The ALl Project would not levy an extra tax on outright transfers but, using the same general approach as the Studies, woul4 do so on trusts which may distribute to grandchildren or more remote descendants at a time later than the deaths of the transferor's children. ABA Evaluation Both of the above proposals are objectionable. A person should be able to provide for ~his Family without a tax penalty. Family includes ancestors, spouse, children, and grandchildren. Outright bequests to grandchildren should not be penalize~d, and the tax rate on transfers in trust should not be determined by reference to the transferor's estate. ABA Alternative Any change in the taxation of trust transfers should be accomplished in such a manner that a person may create a trust having his Family -- his ancestors, spouse, children, and grandchildren -- as its beneficiaries without the imposition of an additional tran8fer tax when compared with current law. The additional tax should be limited to the long-term trust where the property "vests" in a person more remote from the transferor than a grandchild or at a time later than the death of the last living child of the transferor. The tax would be paid from the trust property and should .be determined by inclusion of the trust property in the transfers of the skipped beneficiary--usually a child of the transferor. The result of the ABA alternative would be to eliminate the excessive in- sulation of trusts from taxation but still permit them to be used in a normal way for the benefit of a person's Family without a tax penalty. 5 PAGENO="0297" 283 SUMMARY OF UNIFICATION COMMENTARY Current Law Current law provides separate tax rate structures for lifetime transfers (gifts) and transfers at death. Because each tax rate is progressive, a person can incur gift taxes at relatively low rates and remove property from exposure to higher estate tax rates Further the fact that the gift tax is both a deduction in computing and a credit against the estate tax can be deliberately exploited to achieve substantial tax savings by taxable transfers just before death despite their inclusion in the estate. Major Proposals for Chan&e The 1968 Treasury Studies recommend: (1) all transfers should .be cumulative and be subject to one set of tax rates; (2) all lifetime transfers should be in- creased for computation purposes by the tax the transfer caused (a "tax on a tax" procedure called "grossing-up"); and (3) a change in the law to allow transfers to escape taxation at death even though control is retained so long as a tax was paid at time of transfer and the property could not be regained by the transferor ("the easy-to-complete" transfer rule). Another proposal, which is a "simplified" unification approach, would retain the dual rate structure but would treat all transfers after its effective date as cumulative for purposes of determining the level of the estate tax rate to apply. The ALl Project took no position on a single rate structure applicable to all transfers but did say that a condition to such a change should be a reduction in current estate tax rates. ABA Evaluation The grossing-up concept is unnecessarily complicated and actively discour- ages lifetime transfers The easy-to-complete theory is no improvement but rather a step backward when compared with current law in terms of certainty of operation and sound tax policy. The simplified unification proposal has the virtue of reducing the tax advantage currently enjoyed by persons able to make gifts during lifetime, but offers no lowering of estate taxes to those smaller estates unable to make gifts which the ALl Proj act considered the primary justi- fication for shifting to a single rate schedule ABA Alternative If there is a reduction of estate tax rates the ABA would not oppose the simplified unification approach combined with the elimination of the double deduction for the gift tax paid on a gift in contemplation of death viz a gift tax credit and a deduction in computing the estate tax by in ef- fect allowing a refund of the gift tax paid on the gift These changes would both benefit the smaller estates unable to make gifts and end the tax reduction currently permitted in the case of deliberate transfers in contemplation of death 6 PAGENO="0298" 284 SUMMARY OF MARITAL DEDUCTION COMMENTARY Current Law Current law allows property transferred either outright or subject to the control of a spouse to qualify as a deduction against either estate or gift tax There are quantitative limits on this deduction which for estate tax is one-half of the decedent's gross estate after debts and expenses and for gift tax is one-half of any qualifying transfer Both requirements have been criticized qualitatively--that the dnduction should be available even though the owner spouse retains control over the ultimate disposition of the property; quantita- tively--that all qualifying property should be able to avoid the estate tax until the death of the surviving spouse. Major Proposals for Change Proposals for changes in the law in both the Treasury Studies and ALl Project recommend (1) no quantitative limit and (2) a qualitative dilution in that a transferee spouse would not need to control the property transferred for it to qualify for the marital deduction but merely have a current beneficial interest (an income interest) in the property Vesting of a succeeding interest in the property in someone else would occasion a transfer attributed to the transferee spouse ABA Evaluation The ABA opposes an unlimited marital deduction since this could cause unwise dispositions to achieve a temporary tax advantage at the expense of other family provisions, and because the ABA thinks it poor tax policy to allow very large estates to postpone all taxes until the surviving spouse dies. The ABA believes the problems presented by the current beneficial interest theory outweigh its benefits ABA Alternative The ABA suggests that there be a quantitative change to allow the greater of $250,000 or one-half of a decedent's gross estate to be eligible for the marital deduction but that no major qualitative change be made. 7 PAGENO="0299" 285 COMMENTARY EXEMPTIONS; LEVEL OF TAXATION; FARMS AND CLOSELY HELD BUSINESSES Curreitt Law While the estate and gift tax exemptions ($60,000 and $30 000 respec- tively) and estate and gift tax rates have remained constant since 1942, inflation has severely eroded the purchasing power of the dollar The estate tax has ceased to be only a rich man's tax and now significantly impacts the middle class. In many cases the family residence alone, although purchased at a modest cost by today's standards will require the filing of an estate tax return. The only relief from its impact during this 34 year period occurred indirectly in 1948 as a result of the enactment of the marital deduction, which permits postponement of the tax on 50% of an estate until the death of the surviving spouse The estate tax reaches a 307 rate at a taxable estate of $100 000 and creates particular hardship for estates ~ith farms and other closely held businesses In some cases a sale is required to pay the tax even though the decedent's family would like to continue the operation of the business. This result has been criticized with increased frequency in recent years Major Proposals for Change In recent years, and particularly in this Congress, bills have been introduced to provide estate tax relief. Two major types of changes with significantly different revenue impacts or a combination of both have been proposed: 1 Increase the estate tax exemption Figures in the range of $100 000 to $200 000 have frequently been suggested 2. Restrict the relief to estates with farms and other closely held businesses. Some bills would exempt from all tax farms not exceeding a stated value Other bills would create a special valuation method for such assets In order to qualify the farm or other business would have to be operated by the heirs for a stated period, usually five years, both before and after a decedent's death. ABA Comments Our member banks in frm areas have confirmed the fact that a substan- tial number of farm sales are made by estates and that the number has been increasing in recent years * The primary reason is that the value of farm land has been increasing rapidly. For example, we have been advised by one of our member banks that in central Illinois the value of farm land has 8 PAGENO="0300" 286 increased by 150% during the past 18 to 24 months. The most serious cash problem may not be payment of the estate or death taxes, but rather "buying out" the child or children who will not continue in the business. When there is a surviving spouse, the cash problem is less serious because of the availability of the marital deduction which can reduce the estate tax impact by more than 50%. This problem is often more difficult for a non-farm closely held business than a farm because sale of the business is more difficult than sale of a farm. One important question in considering the farm and closely held business problem is in what percentage of cases does a family member desire to continue the operation of the farm or other business. Iquiries directed to some of our member banks indicate that in a significant number of cases no family member wants to continue actively in a farm's operation. The ABA believes that a sound solution to the farm and closely held business problem should be based upon the following four objectives which are not consistent with each other and must be weighed in terms of their individual importance: 1. Increasing the ability of family members to retain these assets when they desire to do so and continue an active participation in the business; 2. Avoiding a tax incentive of such magnitude (a) that "outsiders" will acquire these assets, (b) that family members will retain assets which should be sold because they cannot be operated with a reasonable profit, or (c) that provide unreasonable distinctions in the treatment of different assets, parti- cularly in the minds of owners of other assets; 3. Minimizing the revenue loss from the tax law changes; and 4. Not further complicating the law. The first objective does not include cases where the heirs desire to retain the asset as an investment but not to participate in the active manage- ment of the business. An~ example of such a case would be where the family desires to retain a farm, but leases the farm to a tenant and does not partici- pate in its management. A substantial increase in the estate tax exemption would satisfy all of the objectives except minimizing the revenue loss. An increase in the $60,000 estate tax exemption to a figure in the $100,000 to $200,000 range would result in a substantial revenue loss when viewed in terms of estate and gift tax collections of $4.5 billion during fiscal 1975. Estimates of this loss, based upon estate tax returns filed during 1973, are as follows: Exemption Billions $100,000 $1.0 $120,000 $1.3 $150,000 $1.7 $180,000 $2.0 $200,000 $2.1 PAGENO="0301" 287 Losses of this magnitude cannot be offset by any other changes in the estate and gift tax area except (1) a change in the income tax basis rule (discussed below) or (2) a significant increase in estate tax rates in the lower and middle ranges Each of these two changes would however adversely affect the same estates intended to benefit from the increased exemption This would be particularly true in the case of farms since their per acre value in early 1975 averaged eleven times higher than in 1940 and three times higher than in 1960 and since the average size of farms has more than doubled in the last 25 years We have assumed that despite the large number of bills introduced in this Congress for an exemption increase, this is not a viable approach because of the substantial impact it would have on estate tax collections. Thus we have searched for another solution with a smaller revenue loss. Also, we believe a substantial increase in the exemption would probably be offset in part by the states increasing their death taxes An alternative to an increased exemption exists for providing estate tax relief to smaller estates at a more modest revenue loss. The operation of the exemption may be changed from a deduction available at an estate's ~gi~est tax rate to a credit against tax at an estate's ~, tax rates. Estimates of the revenue loss from substituting a credit for the current $60,000 exemption based upon estate tax returns filed during 1973 are as follows: Credit Loss $25,000 ($115,000) $400 million $40,000 ($165,000) $940 million $50 000 ($200 000) $1 32 billion The figures in parentheses indicate what taxable estate figure would be required using current rates and no exemption to match the credit and with the preceding exemption table, afford a means of comparing the credit and exemption approaches in terms of revenue loss. The ABA recognizes that a compelling case for providing estate tax relief is presented by estates with farms and closely held businesses, or more specif i- cally those with assets which qualify under Section 6166 for paying the estate tax thereon in up to ten annual installments when the decedent's family desires to participate in the active operation of the business The estate tax which reaches a 30/ rate at a taxable estate of $100 000 forces the sale of farms and closely held businesses in such cases The problem was magnified last year by the increase of the 4% interest rate on estate tax deferred under Section 6166 Unfortunately it is impossible to make reliable estimates regarding the revenue loss that would be involved if tax relief is limited to farms and close~ held business because the Internal Revenue Service does not publish statistics giving totals for estate assets that qualify under Section 6166. The best ju~ ment which we can make is that 10-15% of the gross estate total is attributabi to these assets I 10 A L PAGENO="0302" 288 Various proposals haye been made in recent years to alleyjate the "forced sale" problem. One is to establish a special valuation method for estates that continue to operate the business for a fixed period of time after death, usually set at five years. This is particularly appealing as to farms because of the belief that the market value test produces "inflated" values. Nevertheless, while the value is high based upon the actual rate of return it is realistic in terms of what the farm would bring if sold. The ABA believes the special valuation method presents problems. One is that the federal estate tax audit would still have to resolve the fair market value issue, at least in the case of a sale before the holding period requirement is satisfied. Another problem is that the special valuation method itself would be imprecise and therefore the benefit derived therefrom uncertain. A second proposal is to exempt from estate tax a farm having a value that does not exceed a stated amount. The figure of $200,000 has been suggested. We oppose a complete exemption from tax on the ground that it would create too great a disparity in treatment between farms and closely held businesses and other assets. Also, even if this approach is subjected to restrictions regard- ing the period of time the farm must be operated before and after death, invest- ments by "outsiders" would be encouraged. The Administration recently proposed another solution. It would create a five year moratorium on the payment of estate taxes on certain farms and closely held businesses that qualify under Section 6166, with no interest payable during this period, and would extend the payment period from 10 to 20 years after the end of the moratorium. The 4% rate of interest would be rein- stated. Eligibility would be limited to $300,000 of assets, with a dollar for dollar reduction from $300,000 to $600,000. The ABA believes that a moratorium period is unwise. It would lull heirs into a false sense of security that an estate tax debt is not due and will encourage the retention of farms and closely held businesses which have no long term future. Another way of phrasing our concern is to say that the moratorium provides too much "front end" relief. As proposed~ it is a five year non-interest bearing loan to the estate. Using the 6% rate of return in the Treasury tables, the value of this loan is slightly more than 25% of the amount borrowed, viz., the estate tax on the asset. If tai relief is to be granted, it should be done directly by forgiveness rather than indirectly through a moratorium. An extension of the estate tax payment period from 10 to 20 years is in our opinion undesirable for several reasons. Two of these are (1) our experi- ence indicates that the current 10 year period provides sufficient time for payment in the case of an economicall~,r viable business and (2) a doubling of the payment period will increase the likelihood of an heir dying before payment of the tax is complete in the first estate, thus producing complications in I integrating payments from two estates. The ABA believes the dollar for dollar decrease in eligibility from 300,000 to $600,000 is unsound. The Internal Revenue Service will be given ...o other reasons - tax deferral and the lower interest rate - in addition to an increase in tax for asserting high values. The problems with auditing 11 PAGENO="0303" 289 agents in this regard are bad enough now Also when the eligible amount is say $50 000 or below as a result of the business having a yalue of $550 000 or more, the amount of the tax is not large enough to warrant a moratorium and an extended payment period. The Administration's proposal gives relief in some cases when it should not be granted and gives no relief in more compelling cases. This results from eligibility being based upon the percentage requirement of Section 6166 - 35% of the gross estate or 50% of the taxable estate. A $1,000,000 estate, with $700,000 of liquid assets and a $300,000 farm, which takes full advantage of the marital deduction qualifies because the value of the farm exceeds 50% of the taxable estate. Relief in such a case seems questionable. On the other hand, a more justifiable case would be an estate of $650,000, which included a farm valued at $600 000 where there was no surviving spouse Our experience with Section 6166 demonstrates that the provision is not used in many eligible estates. This is caused in part by the continuing personal liability of the executor for the payment of the postponed taxes. Other technical changes in the Sectionwould improve its utility. The increase in 1975 of the 4% interest rate on estate tax deferred under Section 6166 was ill-advised. Interest as well as the tax itself is a part of the liquidity problem for farms and closely held businesses. The reason for enacting the lower rate in 1958 was to make it easier to pay the postponed tax and interest from the earnings of the business The cash flow problem in this regard would seem as serious today as in 1958. An alternative to a return to the 4% rate would be to set the rate at 2% below the normal rate of interest in effect when the annual installment is due. The 2% difference would be the same as the differente which existed when the normal interest rate was changed last year. A drawback to this alternative is that the estate cannot plan on fixed payments. In general, fixed payments are preferable to fluctuating payments ABA Alternative An increase in the $60,000 exemption should not be considered in a vacuum, but rather as a part of the issue whether estate and gift tax revenues should be increased, decreased or held at approximately the same level. The ABA assumes that the current level of estate and gift tax collections will not be significantly decreased. Based upon this assumption, it believes that (1) the $30,000 gift tax exemption should be retained, (2) the estate tax exemption should be increased to $70,000 ~ that part of the gift tax exemption which is not used during life and (3) the exemption should be changed from a deduc- tion, which may be claimed against a decedent's highest estate tax rates, to a credit against the tax at the lowest estate tax rates. Based upon estate tax returns filed during 1973, the substitution of a credit against tax on the first $100,000 ($70,000 plus a maximum of $30,000) for the $60,000 exemption would re- sult in 47/ of the estates presently filing returns and paying some tax being 12 PAGENO="0304" 290 granted relief from all estate tax. If the estate tax revenues are to be significantly decreased, the ABA would favor rate reduction, particularly in the $100,000 to $500,000 range, over an increase in the exemption. The ABA supports relief for farms and closely held businesses. It believes that the obj ectives referred to above in our evaluation of other proposals are best accomplished by using the existing Section 6166 framework and creating a tax incentive through a partial forgiveness of tax plus interest which increases as the period of time from the decedent's death increases. In order to assure that relief is given only in deserving cases three additional requirements to the ones that now exist to qualify for the ten year installment payment provi- sions would be imposed, namely, that the farm or closely held business be at least 65% of the decedent's adjusted gross estate, that it be owned by the decedent for at least two years prior to his death and that the heirs continue in the business as "operators" rather than as "investors". A clear dividing line between an operator and as investor is not easily drawn, but we believe it may be accomplished with reasonable precision and be based to a considera- ble degree upon continued active participation in the business and in the case of a farm with the heir having farming as a principal occupation. If these requirements are met, the interest rate on the estate tax installment payments~ would also be reduced to 4%. The forgiveness the ABA recommen~Is would be 10% of the first installment and would increase by 5% for each succeeding installment until it is 55% for the tenth installment. The total percentage forgiveness for the full ten year period would be 32-1/2% of the deferred tax plus interest. Most of this f or- giveness would come in the fifth through tenth years. If the value of the farm or closely held business exceeds $400,000, the forgiveness percentages would be reduced by applying a fraction the numerator of which is $400,000 and the denominator of which is the total value of the farm or closely held business. An acceleration of payment of the deferred estate tax under Section 6166(h) would cause a loss of any forgiveness as to the accelerated amount but would not affect forgiveness for installments already paid. We would also point out that our proposal for increasing the marital de- duction to the greater of $250,000 or one-half of a decedent's adjusted gross estate will create indirect tax relief for farms and closely held businesses when there is a surviving spouse. The ABA recommends other changes which will increase the usefulness of the installment payment provisions. These changes would include eliminating (1) the personal liability of a fiduciary for estate tax deferred under Section 6166 and (2) a technical problem that exists under current law to the use of this section when the qualifying asset is held in a trust on the decedent's death. The ABA believes changes should be made in Section 303. This section provides that a distribution of property to a shareholder in redemption of stock is entitled to capital gains treatment (as contrasted to dividend treatment) to the extent that the amount of the distribution does not exceed all death taxes imposed as a result of the decedent's death and all funeral 13 PAGENO="0305" 291 and administration expenses of his estate The percentage requirements of this section are the same as Section 6166 but the time provision is only three years The time period should be extended to the Section 6166 time period On the other hand, Section 303 should be restricted so that it may be used only to the extent the redeeming shareholder is liable for the payment of death taxes or funeral or administration expenses. 14 68-872 0 - 76 - 20 PAGENO="0306" 292 BASIS Current Law Under current law property included in a decedent's gross estate is given an income tax basis equal to its estate tax value. This rule is criticized on the grounds that all net unrealized appreciation occurring prior to the date of death permanently escapes income tax, thus favoring the individual who builds an estate through unrealized appreciation rather than through realized ap- preciation, currently taxable as income and that this escape distorts invest- ment choices by "locking" older people into their investments that have sub- stantial unrealized appreciation. Proposals for Chang~, Two proposals for change suggested are: First, to treat death (and perhaps transfers by gift) as a taxable event and to allow a deduction in computing the estate tax for the income tax on the gains realized by death (the capital gains tax proposal) and, Second, to carry over the decedent's basis for each asset included in his gross estate to the recipient of the asset and then to increase this basis by that part of the estate tax attributable to the unrealized appreciation in the asset at death (the carryover basis proposal). The carryover basis proposal is patterned after the current basis rule of Section 1015(d) for transfers by gift, except that under this section the basis is increased by the entire gift tax paid including that on the donor's cost. It seems reasonable to assume that enactment of the carryover basis proposal would be accompanied by a change in Section 1015(d) to limit the increase in basis to the gift tax attributable to the unrealized appreciation in the asset as con- trasted to the gift tax on the entire value of the gift property. ABA Comments The ABA believes that a change in the basis rule should not be considered in isolation, but rather in conjunction with the issue of transfer tax rates. Estate tax rates are now high and reach a rate of 30% on a taxable estate of $100,000 and a top rate of 77%. State death taxes must also be considered. In many states, they exceed the credit that is allowed under the federal estate tax law, with the result that state death taxes are a part of the "cost of dying." For example, in New York the highest estate tax rate is 5% above the maximum rate of the state death tax credit. Thus, when federal and New York estate taxes are combined, the top rate of tax is 82%. The "cost of dying" is high enough and should not be increased indirectly by a change in the basis rule. 15 PAGENO="0307" 293 If any change in the basis rule is to be mafle, estate tax rates should be significantly reduced. Any such change should also be.acconipanied by (1) lib- eralized rules regarding proof of basis and (ii) a new basis for each asset owned on the effective date of the change equal to its value on that date for the purpose of computing the tax under the "new" law. This position is consist- ent with that taken in the Treasury Studies which recommended the capital gains tax proposal. We recognize that use of a new start-up datemeans that the estate tax reduction would have to be phased in over a period of~ time. An important consideration in determining what form a change in the basis rule should take is simplicity of operation. To the extent possible, a new rule should not complicate the administration of estates. On this point, we find both the carryover basis proposal and the capital gains tax proposal of the Treasury Studies seriously defective. It is indisputable that the simplest system would be one that continues current law to the extent of giving assets included in a decedent's gross estate a basis equal to their estate tax value because no new rules would have to be developed regarding the administration of decedent's estates. Carryover does not do so. Neither does the Treasury Studies capital gains tax proposal because of its exemption from the new tax of property qualifying for the marital or charitable deduction and its complex reallocation of basis procedure. The Studies' hybrid approach, when one of these deductions is present, of part capital gains tax and part carryover combines the worst elements of both proposals. Another important consideration is fairness. Here again we find the capi- tal gains tax proposal, and to a lesser extent carryover, defective. The~ im- pact of the capital gains tax proposal when taken in conjunction with the es- tate tax is uneven and favors the large estate. Put another way, the tax is regressive. This is caused by the removal, through an estate tax deduction for the capital gains tax, from the estate tax base of a portion of the estate assets which would otherwise be taxed at the highest estate tax rate or rates. Thus, the true rate of tax on the gain is a function of the complement of the highest estate tax rate or rates at which the deducted capital gains tax would otherwise be taxed in the estate (i.e., the complement of x is lOO-x). To il- lustrate using current rates, an estate taxed at the highest rate of 77% would be subject to an effective net additional tax commencing at only 23% of the actual capital gains tax paid but an estate whose highest estate tax rate was 30% would be subject to an effective net additional tax of at least 70% of the actual capital gains tax paid. Lower estate tax rates alone cannot remedy the inequitable and unfair impact of the capital gains tax proposal on the medium estate. In place of a single variable--size--presently employed to determine the estate tax, fairness requires that two variables--size and percentage (or amount) of gain--be consid- ered. A reduction in estate tax rates deals with only one of these variables-- size The regressive nature of the capital gains tax proposal may be demonstrated by an illustration using the lower transfer tax rate schedule of the Treasury Studies and the 25% capital gains tax rate in effect when the Studies were pub- lished and comparing two estates one with a $4,500,000 gross estate and an aggregate basis of $1,500,000 and the other with a $450,000 gross estate and an aggregate basis of $150,000. When compared with the estate tax payable 16 PAGENO="0308" 294 under current law, the increase in tax would be 28% for the smaller estate and less than 1% for the larger estate. The percentage difference becomes almost 37/ if current capital gains rates are used and income averaging is ignored. Moving to the carryover basis proposal when a marital deduction or conunun- ity property is present the basis of all es.tate property including that qualify- ing for the marital deduction or the surviving spouse's share of the community would be increased by the estate tax attributable to net appreciation. This result is unfair because property qualifying for the marital leduction or the surviving spouse's share of the community does not generate any estate tax. The entire basis increase should be allocated to the non-marital property and none to the surviving spouse's share of community property. The effect of not making such an allocation will often be to increase the capital gains taxes incurred to raise funds with which to pay estate taxes because the basis increase in the non-marital property will be lower than it would be if the entire increase were allocated to such property. In a separate property estate involving the marital 6eduction, a solution is difficult because it will not be known at a decedent a death what property passes to the marital and non-marital funds and, therefore, the property en- titled to the basis increase is uncertain at the very time sales will be made for taxes. As a result, the Internal Revenue Service would become an active participant in the distribution of estates. In a community property estate, the basis adjustment can easily be allocat- ed entirely to the decedent's half of community assets but in so doing the sur- viving spouse may be penalized. Sales to raise funds for taxes and expenses may include both halves of community assets and the surviving spouse is involuntarily burdened with reporting gain realized as to her community half of each community asset sold for such purposes. Beyond the issues of simplicity and fairness, we have a more fundamental reservation concerning the carryover basis proposal. A part of the tax (i.e., the tax on gain when the property La sold) is deferred until the sale. This, in combination with the addition to basis of the estate tax, makes it very dif- ficult if not impossible to devise a revised estate tax rate structure which will properly reflect the additional tax attributable to carryover. ABA Alternative The ABA believes that if a change is to be made in the basis rule it should take the form of an additional estate tax (AET) on net unrealized appreciation included in a decedent's gross estate. The current basis rule for property in- cluded in a decedent's gross estate that gives such property an income tax basis equal to its estate tax value would be continued. The rule of section 1015(d) for property transferred during life would also be retained except that 17 PAGENO="0309" 295 the part permitting an increase in basis for the gift tax paid which is attribut- able to the transferor's basis would be eliminated The AET would be applied at a single flat rate. In contrast to the capital gains tax proposal, the tax would not be deductible in computing the basic estate tax This fact justifies an AET substantially below the applicable capital gains tax rate or rates. The AET rate should reflect the complement of the highest estate tax rate and the highest capital gains tax rate. In this way a decedent whose estate is subjected to the highest estate tax rate would pay approximately the same AET as he would pay in capital gains tax under the capital gains tax proposal after the estate tax reduction resulting from the deduction for this tax is considered All other decedenta would pay a smaller AET than they would pay in capital gains tax under this proposal if exemptions were ignored We visualize a reduction of the highest estate tax rate to 60/ Using this rate and the current capital gains tax rate o~ 35/ but ignoring the minimum tax the AET would be set at l4/--35/ times 40/ (100-60) A minimum basis equal to the estate tax exemption currently $60 000 would be allowed Thus no AET would be owed by any de'edent's estate not required to file an estate tax return Certain assets, life insurance and annuity contracts, income in respect of a decedent and any item (a collection would be a single item) of tangible personal property held for personal use having a value of $5,000 or less would be deemed to have a basis for AET purposes equal to its estate tax value and thus would not generate any tax * A surviving spouse would be given an election to subj ect her share of community property containing net appreciation to the AET at the time of her spouse's death, in which case her basis would be increased to the property's current value. Property qualifying for the marital deduction would not be exempted from the AET. This does not necessarily mean that the sum of the basic estate tax and the AET would be greater than the current estate tax on an estate using the marital deduction The lower basic estate tax rates plus acceptance of another recom- mendation of the ABA, to increase the amount of the marital deduction (discussed below), would act as an offset to the AET. A deduction could be granted in com- puting the AET based upon the percentage of the gross estate passing to charity. The ABA believes the AlT would be the fairest and easiest methociof changing the basis rule for property included in a decedent's gross estate Nevertheless it does not support enactment, but rather would prefer retention Of the current basis rule 18 PAGENO="0310" 296 GENERATI0N-SKI~ING Cutrent Law Under current estate and gift tax law, the tax imposed on a transfer of property does not take into account the status of the recipient of such property, except in the case of the marital and charitable deductions, and the termination of an interest in a trust such as an income interest is not a taxable event Thus a single transfer tax is imposed on outright transfers that skip one or more generations such as a transfer to a grandchild and on transfers in trust even though two or more generations of beneficiaries will have enjoyed benefits from the trust This result is criticized as eroding the transfer tax based upon the premise that an ideal transfer tax system is one that imposes a tax every generation. Most of the criticism has been directed at transfers in trust, in part because it is possible to give successive generations a combination of interests that come close to full ownership rights. In any estate plan a choice must be made betwee~n an outright transfer and a transfer in trust. The normal expectation of an heir is to receive property outright. Why then should an estate owner make a transfer in trust? It is not to create successive interests in property, because they can be created through legal life estates in combination with remainders or through life insurance and annuities or other contractual relationships A trust is used because it provides flexibility and enables the disposition of property to be altered to accommodate changes in circumstance. An estate plan may be created which will accomplish the estate owner's objectives for his family through the creation of various powers in the trustee and/or beneficiaries, such as investment powers, powers of appointment and powers to pay income and/or prin- cipal to a beneficiary or among the members of a class of beneficiaries. A trust is no more than a single fund in which beneficiaries have interests which re- late to their requirements Proposals for Chang~ The Treasury Studies proposed that an additional transfer tax be imposed upon an outright transfer, or a transfer in trust, of property to a person who is more than one generation below the transferor. Thus an outright transfer to a grand- child of the decedent would be subject to the additional tax. The rate of tax would be 60% of the highest transfer tax rate of the transferor applicable to the transfers during the taxable period if made during life or to the transfers at death if made upon death. The Treasury Studies described the application of the proposal to a transfer in trust as follows: "When the generation-skipping gift or bequest is by trust, there would be generally the same options as to when the tax must be paid as would be available to the skipped generation had he elected to pay the tax. Thus, the transferor or his representative (i.e., executor or trustee) may elect to treat the taxable event as occurring at the time 19 PAGENO="0311" 297 of the original transfer or as of the first day of any calendar quarter thereafter. In no event, however, may the tax be postponed beyond the date of the death of the last survivor among the group consisting of the transferor, his children, and any beneficiaries under the trust who are not within the category of individuals to whom a gift would be considered a generation-skipping gift. At this time, it becomes certain that there is a generation-skipping transfer involved and no reason to further defer the tax." Distributions of current income as well as those of principal or accumulated income would be subject to the additional tax. The American Law Institute proposed another solution. No additional tax would be payable on outright transfers. An additional tax would, however, be imposed on transfers in trust under which distributions are made to a person more than one generation below the transferor at a time later than the death of a per- son or persons one generation below the transferor or in the same generation or in a higher generation than the transferor. Thus, an additional tax would not be payable on a transfer in trust with the income to be paid to a child for life, and the principal to be distributed to the child's issue living upon his death. A tax, if imposed under the ALl proposal, would be computed at the average rate applicable to all transfers by the transferor during the taxable period if made during life or to the transfers at death if made upon death. A third solution, a variant of the ALl proposal, has been proposed. It would not apply to outright transfers but would apply to all transfers in trust for descendants of the transferor, except those where the sole income beneficiary is a child and the child's only interest in the trust is an income interest. Thus, powers of withdrawal and invasion of powers of appointment would not be permitted. ABA Comments The concept of "family" is important. Logically, in the case of outright transfers, an individual ought to be able to leave property to any member of his Family at the price of a single transfer tax. His "family" means persons living at his death. The definition is more difficult In the case of transfers in trust. If the transferor lives out his actuarial life expectancy, "family" consists of spouse, children and grandchildren. With trusts if the transferor dies prior to the expiration of his actuarial life expectancy he ought not to be penalized by a narrower definition of Family; similarly, if he outlives his actuarial life expectancy, he ought not to benefit from a broader definition of "family." The ABA believes each of the proposals discussed above has one or more serious defects. The most unsatisfactory solution is that of the Treasury Studies. It is premised upon the concept that a transfer tax should be imposed every generation even though the skipped generation receives no beneficial inter- est in the transferred property. Leaving aside for the moment the soundness of a 20 PAGENO="0312" 298 once a generation theory of taxation, the Studies proposal does not even apply this theory on a uniform basis to all transfers; transfers to persons in a genet- ation above the transferor (parents), or in the same generation.as the transferor (brothers and sisters), are not exempted from the transfer tax as they should be if the theory is to be applied impartially. Returning to the soundness of this theory, we dà not understand why an additional tax on outright transfers to grand- children is appropriate. One of the stated objectives for transfer taxation is dispersal of wealth. If this is so, why should transfers that disperse wealth be penalized? If there is an abuse in the generationskipping area, it exists only where a splitting of benefits between generations is present. This does not occur with an outright transfer. Further, the transfer tax wheel of fortune commences immediately upon an outright transfer and an "early" death of the donee will trigger off inclusion in his estate. Finally, we know of no country or state that has imposed an additional transfer tax on outright generation-skipping transfers. While the fact that an idea has not been tried before does not auto- matically justify its rejection, it does suggest that an additional or substitute tax on outright generation-skipping transfers is alien to the concept of f air- ness regarding transfer taxation. For three reasons, the ABA disagrees with the proposals of the Treasury Studies and the ALl concerning the determination of the amount and time of pay- ment of the additional tax for transfers in trust, which in our judgment impose the tax at the "wrong" time on the "wrong" person: First, the additional tax is computed by reference to the transferor's tax rates and is therefore inconsistent with the Studies every generation tax. The tax should be computed with reference to the estate of the skipped generation. Second, the tax is dependent upon the transferor's rate applicable at the time of transfer. It is inappropriate to create an incentive for making genera- tion-skipping transfers early when the transferor's tax rate is. low. Third, the election device permitting the tax to be determined based upon value at the time of transfer or at a later time is ill-advised and injects aspects of a lottery into the computation of the tax. We have other difficulties with the proposals. The application of the Treasury proposal to the distribution of current income will create complexity. If the additional tax is to be paid from the distributed income, the income tax plus the additional tax may exceed 100%. Also, the ALl proposal may be criti- cized in that, by imposing a single additional tax that is not related to the term of the trust or the number of generations Skipped, the creation of long'- term trusts is encouraged. The third proposal described above--to exempt from an additional tax trans- fers in trust for a child where the child's sole interest in the trust is an income interest--is unsatisfactory in that it is inconsistent with the clear end socially desirable trend toward flexibility in trust dispositions ABA Alternative The ABA believes that any change in the taxation of trust transfers should. be accomplished in such a manner that a person may create a trust having his 21 PAGENO="0313" 299 family' --his ancestors spouse children and grandchildren--as its benefici- aries without the imposition of an additional transfer tax when compared with current law The additional tax should be limited to the long-term trust where the property `vests in a person more remote from the transferor than a grand- child or at a later time than the death of the last living child of the trans- feror. The tax would be paid from the trust property and be.determined by in- clusion of the trust property in the transfers of the "skipped' beneficiary-- usually a child of the transferor The effect of the ABA proposal in the context or a trust for descendants of the transferor would be to shorten the period during which trust property may be kept outside of the transfer tax base from as much as 100 years to a period not to exceed the life or lives of children of the transferor. The ABA proposal t~ould not inhibit in any way the use of a flexible trust through the creation of various powers in the trustee and/or beneficiary, such as powers of appointment and discretionary po*~ers to pay income or principal among a class of beneficiaries. A more detailed explanation of the proposal is con- tained in Appendix A 22 PAGENO="0314" 300 UNIFICATION Current Law Cenerally speaking, an estate tax is imposed on transfers at death and.a gift tax on transfers during life. Each tax has a separate rate schedule and a separate set of exemptions. The effect of a gift is to remove property from the top estate tax rate at the cost of a gift tax computed in almost all cases at a substantially lover gift tax rate. As a consequence a tax advantage is derived* from gifts under current law. The existing dual system has been criticized as preferring the wealthy individual who can afford to make gifts over the less well-to-do individual who cannot afford to do so Proposals for Chai~g~ `Two proposals for changing the present dual estate and gift tax system have been made: First, to "unify" the estate and gift tax laws. As suggested in the Treasury Studies, this proposal would have three facets. One, transfers during life and at death would be subject to one set of rates that would be applied cumulatively. To give a simple illustration and ignoring exemptions, if a man transferred $50,000 during his lifetime this amount would be subject to tax at the lowest rate and upon his death the initial rate applicable to his transfers at death would begin with the rate applicable to $50,000. Two, a "grossing-up" concept would be created under which an individual making a gift of property during his lifetime would be subjected to transfer tax not only on the value pf the property transferred but also on the transfer tax itself. Under current law, an individual making a gift pays a gift tax only on the amount of the gift. Three, a shift would be made from what is now a "hard-to-complete" rule on the time of imposing the tax to an "easy-to-complete" rule. Under the current "hard-to-complete" rule, a transferor may remove tru~t property from his gross estate only if he gives up both beneficial enjoyment of the property and the right to control who will receive the income or principal of the trust or the time of its enjoyment. Under an "easy-to-complete" rule a transferor could retain control over, but not beneficial enjoyment of, the trust property and still not have the property included in his transfers at death. Second, to retain the existing dual structure but to compute the estate tax by, in effect, including the amount of the decedent's taxable gifts in his gross estate for the purpose of determining the applicable estate tax rates. The estate tax payable would then be the difference between (1) the estate tax that would be payable on his taxable estate plus an amount equal to his taxable gifts and the gift tax ,paid, and (2) the estate tax that would be payable if his taxable estate consisted only of his taxable gifts and the gift tax paid. 23 PAGENO="0315" 301 ABA Comments The ABA opposes the "grossing-up" concept as being an inappropriate way of taxing a lifetime transfer which is different from a transfer at death Also we see no reason to impose this complication which would introduce an algebraic formula into the tax computation and the confusion that would result for the sake of logical symmetry in the method of determining the tax on lifetime trans- fers and deathtiine transfers With respect to shifting from a hard-to-complete to an easy-to-complete transfer tax rule we believe that as a matter of tax policy such a shift is wrong. An individual should not be permitted to insulate future appreciation or income accumulations from transfer tax when he retains control over the trans- ferred property. Anpther reason why we oppose an "easy-to-complete" rule is that it would involve changing present estate tax law which is now reasonably clear in its effect after many years of interpretation. Unless there is a provable advantage to the "easy-to-complete" rule, the time spent in shifting from existing law to the new approach is an unproductive use of time and money. A shift to an "easy-to-complete" rule is usually justified on one or both of two premises. We believe that each of the premises is incorrect. The first premise is that although we have struggled for many years to draw a line between complete and incomplete transfers, using a "hard-to-complete" approach, we have the skill to draw an "easy-to-complete" line which is free from doubt. Our experience with tax law makes us doubt that this is true. A line between a taxable transaction and a non-taxable transaction is always hard to draw. We should not abandon the knowledge which we have painfully acquired ovet the years regarding the "hard-to-complete" rule. The second premise is that since all transfers will be subject to a single rate schedule even an imprecise dividing line will not generate controversy. This is erroneous. If an individual makes a lifetime transfer and the property appreciates in value, it is to the Government's advantage to take the position that the transfer is a deathtinie rather than a lifetime transfer. Under exist- ing law, increases in value between the time of transfer -and the time of death, more than rate differentials, cause the Government to challenge the time of completion of the transfer. An "easy-to-complete" rule will not change this situation unless the law is drafted so that, if an individual makes a transfer during life and pays a tax, the Government is estopped from raising the question of the time of completion of the transfer for transfer tax purposes. Absent such an objective test, existing law is superior because of the knowledge acquired as to the time of transfer. Further, we do not think that the Government should make such a concession. The second and simplified "unification" proposal discussed above is unsatis- factory in that it would not be accompanied by a reduction in estate tax rates and the person of modest means who does not feel able to make lifetime gifts would not be benefited by the change. 24 I PAGENO="0316" 302 ABA Alternative The ABA believes that the simplified `unification' proposal discussed above is worthy of cons~deration ~but only if the current estate tax rate schedule is reduced Otherwise there would be no benefit to be derived from the change for the person of relatively modest means who cannot `afford to give property away during his lifetime The present rules which permit a double deduction' for the gift tax paid on a gift in contemplation of death, viz., a gift tax credit and a deduction in computing the estate tax, should be eliminated by in effect allowing a refund of the gift tax paid on the gift For the reasons given above the ABA favors retention of the hard-to-complete transfer tax rule. 25 PAGENO="0317" 303 MARITAL DEDUCTION Current Law A marital deduction of 50% of a decedent's adjusted gross estate is avail- able for property passing to a surviving spouse This deduction is also avail- able for lifetime transfers to a spouse subject to the same 50% limitation. In order to secure the deduction, the spouse must be given the unrestricted right to control the disposition of the qualifying property either during life or at death. Current law has been criticized both quantitatively and qualitatively, and also as being unnecessarily complex. As to quantity, it is contended that spouses view property owned by each of them as "their" property and that a tax should not be imposed until both spouses have died. As to quality, the conten- tion is made that the transferor spouse is put to an unfair and unnecessary choice in that in order to obtain the deduction the other spouse must be given control over the marital deduction property and this may not be desired partic- ularly in cases where there is a second marriage and children by a first marriage Proposals for Chan~ The Treasury Studies and the ALT recommended liberalization of the marital deduction provisions in terms of both quantity and quality; no limit would be placed on the amount of property which could be transferred free of transfer tax between spouses and a life estate (or income interest), viz., a current benef i- cial interest in property unaccompanied by a power of disposition (appointment) in the spouse, would be permitted to qualify for the deduction. ABA Comments The recommendations of the Treasury Studies and the ALT are appealing. They do however present some significant problems With regard to an unlimited marital deduction the problems are twofold First a complete exemption from tax for transfers to a spouse would encourage such transfers at the expense of trans- fers to other members of the transferor's family When the spouse will need all of the income to live on--as will usually be the case with the small and medium size estate--this result should not have an adverse effect However in the case of a large estate where the income is more than sufficient to satisfy the spouse's needs the tax pull of avoiding all tax may lead to unwise dispositions ignoring other family members at least until after the spouse's death A shift to a current beneficial enjoyment theory for marital deduction qualification would be helpful particularly in cases of second marriages and children by a first mar- riage in permitting the first spouse to die to control the disposition of the property after the surviving spouse's death Nevertheless the problem will to some extent remaim Second when a part of the estate is more than sufficient to satisfy the spouse's needs we question whether postponement of the collection of all tax as a result of an unlimited marital deduction should be permitted 26 PAGENO="0318" 304 With regard to the current beneficial enjoyment test, one problem is "forc- ing" transfers upon the surviving spouse as a result of the termination of the current beneficial interest prior to death. In such a case, later transfers by that spouse will result in a higher tax because the "forced" transfer will result in the application of higher transfer tax rates. This problem could be eliminated by requiring that the spouse's interest cannot be terminated during life without his or her consent. We have encountered amung our members a substantial amount of opposition to a shift to a current beneficial enjoyment test. A chax~ge is opposed because: (1) It will result in considerable litigation even though it resembles the income requirement of a marital deduction trust under current law. (2) It will produce undesirable complexity because of the absence of control in the surviving spouse through a power of appointment. The fact that the same type of interest may both qualify and not qualify for the deduction may create tracing problems. (3) It will tend to produce an inconsistency between the estate tax law and applicable elective share laws of a majority of coinmun law states under which a surviving spouse is entitled to an outrig~, share of a dccc- dent's estate. (4) It will create a further disparity in property dispositions between community property and common law states. Under community property laws, a surviving spouse has control of her half of the community property and under current law the surviving spouse in common law states must receive this control in order to qualify the property for the marital deduction. (5) It will produce more conflict between the surviving spouse and the remaindermen over what is an appropriate level of income, particularly in the case of second marriages where an adversity is more likely to exist between the spouse and the remaindermen. (6) It will raise some technical problems regarding its application to annuities which are avoided if current law is retained. ABA Alternative The ABA suggests that the current marital deduction law be modified quan- titatively to permit qualification of the greater of $250,000 or 50% of a decedent's adjusted gross estate but that no qualitative change be made. xxxxxx Future developments may of course cause a change in our thinking con- cerning the matters that have been discussed. 27 PAGENO="0319" 305 APPENDIX A Explanation of ABA Proposal Imposing a Tax on Certain Trust Transfers The ABA solution is to subject to transfer tax the "value of property pass- ing' to a beneficiary's descendants' upon a "termination or distribution by imputing ownership to the beneficiary of the property so pa8s~ng unless an "excluded transfer" is present. Each of the quoted terms is given a defined meaning. Three of these terms, "te±mination", "distributioC" and "excluded transfer" are of primary importance. Their meanings may be suirthiarized as follows: Distribution -- a transfer causing property to cease to be a part of a trust. Termination -- any occurrence, other than a distribution, causing a person to cease to be a beneficiary of a trust. The occurrence will usually be the beneficiary's death. Excluded Transfer -- this term is defined separately for distributions and terminations. Any distribution to a child or grandchild of the transferor or to a person no more than two generations below the transferor is an excluded trans- fer. Any terminatioC is an excluded transfer if immediately After such occur- rence there is a beneficiary of the trust who is no more than one generation below the transferor. A payment of current income is not treated as a distribution or* a termina- tion. The general scâpe of the excluded transfer provisions may be illustrated by two examples: Example 1. A creates a trust with income payable to his son B for life,~ remainder upon B' s death to his then living issue, per stirpes . Any property distributed to a grandchild of A upon B's death is an excluded transfer. Example 2. A creates a trust to continue until the death of the survivor of his three children, with the~ income to be distributed currently to any one or more of the issue of A then living as the trustee determines and the princi- pal to be paid upon the death;of the last surviving child to A's issue then living, per stirpes. No payment of current income, even if made to a great- grandchild of A, is subject to transfer tax. The terminations caused by the deaths of the first two children to die or by the death of any grandchild or more remote descendant of A (each of whom is a "beneficiary") are excluded transfers At the death of the last surviving child the `termination excluded transfer provision would not apply but the distribution excluded transfer provision would apply to the extent trust property is distributed to a grand- child of A. If at the death of the last surviving child trust property is distributed to a great-grandchild of A, a transfer tax will be paid with respect to such property. 28 PAGENO="0320" 306 APPEN~DIX C Changes in Draft Statute If a policy decision shouid be made to enact an AET but, in computing the tax to allow a deduction for charitable transfers the following changes should be made in the Draft Statute: In Section 2 \ 1. Subsection (d) should be redesignated as Subsection (e). 2. Subsection (a)(l) should be revised to read: "(a)(l) Imposition of Tax. - An additional tax of 14 percent is hereby imposed on the net appreciation in the value of the property transferred by a citizen or resident of the United States at death. For the purposes of this section "(A) the term `net appreciation' shall mean the excess of (i) the fair market value of all property so transferred (as determined for purposes of imposing the tax under section 10 over (ii) the basis of such property; and "(B) property transferred at death shall be deemed to include all property transferred within a period of two years ending with the date of death to the extent that the property so transferred has not been disposed of prior to death in a transaction which results in the recognition in full of gain or loss." PAGENO="0321" 307 3. "A new subsection (d) should be insetted to read": (d) Deduction for Appreciation in Property Transferred ~or Public, Charitable or Religious Uses. - In determining the amoünf of net appreciation subject to the additional tax under subsection (a)(l), there shall be deducted an amount equal to the net apprecia- tion which would be subject to tax under subsection (a)(l) multiplied by a fraction, the numerator of which is that part of the vali~e of all property transferred at death which passes for the uses or purposes described in subsection (a) of Section 31 and the denominator of which is the value of all property transferred at death." In Section 31 Subsection (c) will begin "If the tax imposed by Secti~n I or 2, or * *", ~iScussion The AET charitable deduction is based upon the percentage of the ~ransfers at death or within two years of death which pass to c1~arity rather than related to the actual net appreciation passing to charity under' the governing instrument. Thus, a tracing approach is rejected and there is no tax benefit to be derived from leaving the assets with th~ largest appreciation to charity. The words "that part of the value of all propetty transferzed at death which passes for the uses o~ purposes described in subseOioa (a) of Settion 31" describing the numerator of the frettion in subjection (d) will, in the usual case, refer only to the amount of charitab1~ dedettion allowable under Section~ 31.. If, however, a charitable claim is allowable 68872-76-~..~~2i PAGENO="0322" 308 under Section 29(a)(3)(ii), the amount of the claim would be added to the numerator and if a transfer was made within two years of death and at deatht a charitable interest exists and the interest would be deductible under Section 31 if transferred at death, the value of this interest would also be added to the numerator, By referring to Section 2 in subsection (c) of Section 31, the Section 31 deduction will be computed after reflecting any AET that is payable from property otherwise passing to charity. Thus, the Section 31. deduction will be reduced by any basic estate tax or AET chargeable to charity's share of a decedent's property. In some cases, the computation of the AET charitable deduction and the Section 31 charitable deduction will be interdependent. Of the 120,761 estate tax returns filed duting 1973 which showed a tax payable, a charitable deduction was claimed on only 15,993. Thus, au AET charitable deduction would affect only a small percentage of the returns which are filed. Similarly, the revenue effect of the deduction would be modest since a significant part of the $l.692 billion claimed in, 1973 woui4 not be itt the form of net appreciation but rather a "return" of basis, * *. There is an omission of five words in Section 2(b)(3). The words "distribution of capital gain as" should be inse~ted immediately before the word "provided". PAGENO="0323" 309 STA~EMUT OP WTLLIAMtC. PENIOI~ Mr. P1~Nro1~. Thank you, Mr. Chairn~an. It is a pleasure for us to participate in your hearings on e~tate and gift tax reform, With me and ~also~representir~g the Ai~eric~n Insti- tute of Certified Public Accouiits are Arthur Hoffman, chairman of our committee on financial and estate planning, and Joel ~`orster, director of our tax division. Several years ago we commenced ~ series of studies ~n t~ie major issues in estate and gift tax reform. These studies cuimin~ted in a statement of tax policy on estate and gift tax reform, and copies were furnished several weeks ago for inclusion in the committe~ print of background materials on Federal estate and gift taxation. Since this statement analyzes the issues and explains our conclusions and recom- mendations, I will not take the time this morning to review il~ in detail. I will try to summarize our positions, and make a few general remarks about the overall impact of estate and gift taxes on our econbmy. * The five major areas that we have considered are: (1) ~eneration skipping transfers; (2) the marital deduction; (3) appreciated assets transferred at death; (4) unified transfer ta~; and (5) lib~ralizüion of deferredpayment of Federal estate taxes. I. GENERATION sKIrPrN~ TRANSFERS Under current law an individual can transfer property, by gift or b~quest, to a person twoor more ganerations removed and~ so long as a~ intervening generation is liw~ted to an income interest, no estate or; gift tax is imposed on the intervening generation. This has been characterized as an abuse since it does permit transf~rs of p~operty for the `benefit o~everal generations without ta~ing each lev4. Our posi- tion is that there should be a tax upon tr~nsfers imtru~t with an income interest to an intervening generation, b~t we favor the ~pproaoh of imposing the 1j~x on the estate of ~the intervening generation, rather than on the `testeter or settiçn~. This additional tax would not apply to direct generatiØn skipping transfers where the m,emb~r of ~ hals no income interest in the property transferred. We find nothii~ socially or economioalI~ inequithbie~ in gifth or bequests that totail~skip a generation. There are a number ~f refinemente that would have to bi considered, should this concèp~t be ~adopted~ Sqrne of them are discUssed in our `policy statement. II. THE ~ARITAL DEDtOTION Under present law a decedent may tra~nsfer. up to one-half of iiis estate to his spouse free of tax, so long as the interest trai~sferred does not lapse because of the passage of time or the occurrence of certain eventa This is the so-called terminable interest rule. We oppose a change that ~yould permit an unlimited n'~arital deduc- tion. We recognize the problem of ade~p,iate protection tp a surviving spouse in medium-sized estates, but believe ~that an `increase in the existing $60,000 exemption level, whioh ~we~ will discusi later, along PAGENO="0324" 310 with retention of the present marital deduction rules, will provide adequate protection. A change to an unlimited marital deduction would probably be of much greater benefit to larger estates, resulting in substantial revenue loss and adding complexity to existing laws. III. AP~JCXAT~D ASSETS PEANS~1ERRED AT DeATh This has been one of the. moat. `controversial, areas for discussion of possible estate and gift tax changes. TJnder present law,, the fair mar- ket value of appreciated assets transferred at death is subjoct to estate taxes, but the unrealized appreciation element is not subject to income taxes.. In addition, the beneficiary of assets received through an estate acquires a new tax basis in such assets so that, if he later sells them, there might not be any gain subject to income taxes, depending of course on future values. You are aware of the alternatives that have been suggested 1k either (1) impose an additional tax at the tim& of death, perhaps equivalent to a capital gains tax had the appreciated property' been. sold, or (2) continue the decedent's basis in the property in the hands of the beneficiary. We have reviewed very carefully these alternatives, and recommend that neither of them be adopted. In our view, it is incorrect to say that unrealized appreciation is not subject to tax; since it is subject to up to a 77-percent level of estate `taxes. It is also important to keep in mind the basic premise that estate and gift taxes as a whole are in effect a levy on capital'. With our likely shortage of capital both present and for the' foreseeable future, we' are concerned with a change that would" impose an additional levy em the capital represented by the unrealized appreciation of assetS transferred through an estate. Both of the' basic proposals for change in this area wuml!d introdu~ significant complexities, and' we do not think the alleged be~efits de~ rived would be sufficient to o~set them. We have worked with thepres- ent system for many years and there is merit in contMuing a system that is understood and that reaches a reasonable result. i~. ~Ifl~D~ ThANS~R ThX Under present law,. a $~@~0~0 exemption is provided for estate taxes, a $30,000 lifetime exemption for gift taxes, and~ $~,OOG amtual d~onee exclusions for gift tax p:urposes. Furthermore, the' gift' tax rates, which are graduated, are~ generally 75 percent of the e~uival'ent estate tax rates. The combination of these factors has led to opportunities. for tax planning through. lifetime' gif ts;. the. net effect of which is to trans- fer property to a beneficiary at a lower tax cost than would be the case had it passed through an estate. Several proposals for changing these provisions have been made, and they are discussed in our position paper. They range from con- tinuation of the present systems to a complete integration of the two systems, so that the same tax rate would apply whether property is transferred by gift or by bequest. Our proposal is somewhere in between. We support continuation' `of the dual' rate structure under which lifetime gifts would be taxed cur~ PAGENO="0325" .311 rently at a lower rate, 15 percent of the equival~ent estate tax rate. How- ever, lifeti~ne gifts wouid be added back to a decedant~s estate to the extent of 75 percent of their value. Upon death, a c~ed4t would be al~ lowable ~gainst the estate tax for the gift ta~ previously paid. A major el&nent of our recommendation is an increase in the com- bined exemption for estate and gift tax purposes to $150,000. The present exemption levels, which have been in the law for many years, ~ clearly too low hi view of th~ groat infIatio~i that ha~ occurred over the last few years. As a matter of fact, our study of this issue was com- pleted some time ago, and if we were reviewing our position today, we would probably favor a higher level-possibly $200,000. V. LIBERALIZATION OP DEFERRED PAYMENT OP P~DERAIJ 1~STATE TAX Section 6166 has been in the law for nearly 1~ years. One of its principal objectives is to partially reduce `the~problem of liquidity, par- ticularly for small- and medium-size estate *ith investments in closely held companies. The need for this type of legislation is increasing, and we advocate extending the concept and broadening the definition of the types of situations that will qualify. Furth~rm~e, while this does not relate directly to section 6166, we strongly urga that the interest rate on the payment of taxes deferred under section 61&6 be i~stored to its prior level of tw~thirds of the normal deficiency interest rate. The change made hi the Tax Reduc- tion Act last year in effect raised the rate from 4 percent to ~ percent, now 7 percent, and this has reduced substantially the benefits under section 6166. We urge that' the two~thirds relationship to the normal interest rate be restored. In summary, we believe that certain structural changes in our estate and gift tax laws are ~ppropriate. 1The changes that we support have been covered briefly today, and are e~piained in more detail in our written ststement. Aside from thi~, bewever, we think that, as your committee reviews the overall impact of our estate and gift ta~ system, it shomid heap in mind that these taxes are in essence levies on capital. If you are ecaicerned, as we are, with the avaiWdli'ty of capital to meet the mat~y needs that `we have ~vithin em' conatry, we think yen should recognize that an~y Increases in the overall impact of these taxes will deci~ease the pool~of cajpital available to meet those ~ieeds. Finally, the .ov?emil restrneturing o~ our estate and gift tax `system is en `ambitious nudartaking, to sray the least. In all likelihood, both Houses of Congress will not have time to consider the fundamental issues that are involved this year. Therefore, as an immediate Qbjec- tive, we ~trge that serious ~cceiside~tion be giveiia `to a substantial in- crease in the e~tate'M~ e~mnption. `The~$U0$)00 arnnmit has `been in the law well over 30 years, and it is no 1ong~- appropriate hi view of the great inflation that has occurred since its adoption This is of. im- mediate concern to small h~sinesses,, asid ~a ohu~nge is needed now to avoid forced sales and the taxation of inflated values. We appreciate the opportuthty to appear before your commitee, and wiAl be pl~tsed ~te try to ~nswer f~u~y ~pi~estã~s that you might have. i~he~C~IanmtAN. T&ai± you ~eryrnueh, Mr. Penick. Without dhject~on, the fu~li statemen~t sup~leme~tal m ei~ia,~s will be included in the record. [The materials follow:] PAGENO="0326" 312 SYNOPSIS OF AICPA POSITION i?he American Institute of Certified Public Accountants supports estate and gift tax reform legigiation in the following key areas: 1. Generation-skipping Transfers.-Under current law, an Individual can make a transfer of property to a descendant two generations removed and, so long as Intervening generations are limited to a mere economic interest (i.e., an income Interest), no estate or gift tax is Imposed on the intervening generation. We recommend: No Imposition, of tax on outright transfers benefiting a "skipped" generation; Imposition of a tax on creation of Inter vivos and testamentary trusts which benefit a skipped generation; Basing such tax on actuarially determined values; Imposing such tax on the estate of the skipped generation and making it payable from. trust corpus; and A liberal dtsclaimer provision and extension of the previously taxed prop~ erty tax credit for a period of up to 25 yeirs. 2. The Marital Deduetion.-Under present law `a decedent may t~~ansfer up to one half of his estate to his spouse free of tax'so long as the Interest transferred does not lapse because of the passage of time or occurrence of certain events ("terminable interest rule"). We recommend: Retention of the 50 percent marital deduction limitation; Retention of the terminable interest rule; and As stated below, an exemption level of $150,000 which would permit a $300,000 estate to pass free of tax. 8. Appreoiated 4ssets Transferred at Death.-At present, where a decedent dies owning appreciated assets, the appreciation is not subject to the income tax, and the beneficiaries take a basis in the property received equal toits fair market value. We recommend retention of our present system in this area. 4. Unified Transfer Ta~r.-~-Tbere currently exists an exemption from the estate tax of $60,000, and a lifetime gift tax exemption Qf $80,000 per donOr. In addi~ tion, there Is an annual exclusion of $3,000 for each donee for gifts of present Interests. We recommend Unification of these two systems of transfer taxes; Retention of the present estate and gift tax rates; That upqn death, there be included in the estate ta~ computatIon 75 i)or~ `cent of the fair market value of Inter vivos gifts made; Allowance of a credit for gift taxes paid on Inter vivos gifts; Retention of the $3,000 annual gift tax en~clusion; and Increasing' to $150,000 the current combined $90,000 exemption for estate and gift taxes. 5. LiberaZi~ation of' Deferred Payment of Federal Estate Tae.-Under present law, an extepsion of time to pay the federal estate tax may be granted in two situations :1). where payment of the tax would result in "undue hardship" to the estate (SectIon 6161): 2) where the estate consists largely of an IntereSt in a closely held business (Section 6166). In addition, Section 303 permIts certain redemption distributions to be made to help in paying the estate tax, without certain adverse income tax consequences. We recommend: Treatment as a single corporation, for both Sections 303 and 6166 pnrpo~es, a decedent's interest in two or more corporations if the estate owns more than 50 percent of each; No change in the amount of redemption proceeds qualifying under Section 803: Liberalization of ownership requirements In connection with the payment of estate taxes where an estate consists largely of an interest in a closely held business; and Liberalization of Section 6161 with regard to ex~enisons of time for pay~ ment of the tax. ~ Traa$fer$ BACKOROVND Utider current law, a pei~son may transfer property by gift or bequest to a lineal descendant more than one generation removed from himself (for example, a grandchild) and, as a result, the transfer tax is not paid by the intervening generation. In addition to outright transfers, a settler may make a taxable PAGENO="0327" 313 transfer of property and not have the property subject to transfer tax again for ~several generations with the use of trust instrume~ats which satisfy the rule ngainst perpetuities. This is true although same elements of beneficial enjoyment ~of the property accrue to the intervening (or skipped) ~generatlons. DISOUSSIOI~ Genera~ The UM. Treasury Dep~rt~e1~t Tax Reform Sti~dies and Proposals dated February 5, 19~9,1 pertainittg th estate tax, recommended a tax upon generation skipping transfers. It was proposed' to Impose a "substitute" tax, in addition to the present transfer taxes, if property is transferred to a ~randcbild or more remote generation, This tax upon g~neratiou skipping (`GSP)' would apply to outright transfers as well as transfers in truet. `The tax would be 60 percent of the basic transfer tax unless the member of the "skipped" generation elected to treat the transfer as a gift or bequest to him and a simultaneous gift to the `next ~generation. Position of other professionai groups On April 30, 1~68, the Aiherican Law Institute (A~LI) issued a report entitled "Federal Estate and Gift Tax Project." 2 ~ was therein reported that the Oouncil to the'Menlbers of the `ALT approved a resolution to recommend a GST only upon a very limited class of transfers. Basically, the ALl proposal was to have a GST only upon transfers in trust that would vest in a your~ger generatior~ at a time subsequent to the time of death of the immediately succeeding generation. In ~other words, if the trust provided for income for benefit of ~ child and the remainder to a grandchild upon the death of the child, there would be no additional tax. If, however, the trust continued after the death ~f the child with the remainder to a great-grandchild upon the grandchild's death2 there would be -an additional tax. The American Bankers AssQciation (ABA) would also limit1 the GS1' solely to transfers In trust. The ABA, in general, would impose a QST, only if the `transfer skips more than one generation. , `` ` Z~OPO5ALS ,` 7The AI(JPA's position lIe that there should be a tax upon tra~fers lu `trust that s~ip a generation, ttn~t it favors a limited Inclusion In the estate of `the member of `1~he skipped generation, provided ~~eb perSon had a beneficial interest in the trust. ~he ATOPA, therefore,.makes the following proposals. / No separate generation skipping to~a~ on test at or or settlór-To' the extent that there would `be a tax on the prope~tV passing to a grandchild or huter generation, ~uch tax would be computed by including a value iii the gross estate of the t'sklpped" person. The tax would be due at th~ time that `person's estate tax is ~due. Thus, no, additional tax would he due from the settlor of an inter vivos gift / In, trust nor from thç e~tate of the creator of a testaxx~entary trust, The tax would be payable from the èorpus' of the trust. If a generation obtains, its interest in `the trust or `the property in a manner other than by death of the ~k1pped generation (s~~h, as after a term certain), the tax would be payable at the time of transfer of interest as though the generation ~bose interest bad terminated had ~nade a gift. No a&UtionaZ tao' on outrig1~t gifts or beque~t&-Only gifts In trust would be Included in the gross estate of the "skipped" persç~L. Also, only. fo the extent that - `the "skipped" person had a beneficial Interest would there be an Inclusion. Inclusion in grOss estate based~ np~on actuarial vaiues;-If a, person's beneficial interest, in- a trust exptres a.nd If a more remote generation from the grantor that such person- wIU obtain an' interest `(for example, if the son of a grantor dies and the corpus goes to the grantor's grandchild) -then a computation would be made of an `amount to be included in the estate (or taxable gifts) of such a person. The fair market value- of the corpus at the date of such, tç~rmtriatlon would be calcu- lated. A pro `rata portion of this far market value W~ul4 -be Included. in the cal- ~culation of his gift tax. The portion iucluded,would- be based upon an actuarial 111.5. Treasury Department, "Tax -Reform -Studies and Proposa1s~" 4~ Treasury Tax Study (Washington, D.C., Feb. 5, 1969), hereInafter referred, to' as 1969 T~asury Proposals. All suhse~nent direct citatiOns of `this report will be indicated by page number within the body of the text. ` - . " , - Published as Federal Fetate and ai~t Taxation: Reca~amendaflons Adopted bjl the .Asaerican Zcw~ Institute at Washington, D.C., May 23-4, Z9GL, - PAGENO="0328" 314 computatto* of the i~nter~st so `t~rminated. This coi~pntathm won~d be made as of the date the trust ~s created (or at the date it became ir~ei~ocab1e if this Is later). If the decedent was solely an ~icome beneficiary, the actuarial value would be based upon present value tables of a life-income interest using the age of the $neflciary as of the date of the commencement of his income Interest in. the trust. If his interest was only for a term of years, then the calculation would be based upon that period. The AICPA believes, however, that the present six percent table is too high for this purpose. A table based i~pon a ±Our aiid one-half percent or five percent returnwould appear to be more equitable, Eayarn~Ze.-Assume ~tba~t a father dies at ~a time *hen his son Is age forty-five. Father leaves $i~000,000 in tr~ist with income to his son, and upon the son's death, the rei~sainder to his grandchildren. When the son cUes, the corjus has a fair market vatue of $2~000,000. The present value at fIve percent of the `ight to use 4~1 for the li~e~f a 45-year-old persan l~ about 62 percen.t. Thus, 62 percent of the $2,000,000 date-of-death value would be subject to estate tax upon the death of the life beneficiary. The amount subject to tax would be limited to the interest passing to the next generation. The estate ~ax would be paid out of the trii~t corpus untess the life beneficiary provided by will or otherwise that the tax should ~me from his eState. The tax charged to the corpus would be from the top brackets. Tbus~ the per- sonál estate `of the life beneficiary would not be si~ected by the inclusion of the life intereSt in the taxcomputation. W'itJ~ apr ki1mi~ fru~t, ta~eaUon ~f corpse upon death of last bene~eiary~to die.- The question fl~rlses as to the best mOthod of taxing the corpus when the income m~y be paid to ~iny m~iuber at a `class that includes more than one member of the "~ktpped" g4neratl~n `thro~h the use of `a sprinkling trust The AICPA Tecognizes that `a~gñmen1~s e~iild be ~nS'de for taxing a partion at the corpus as each bene- ficiary dies Arguments could also be made for taxing the corpus when the last member ~1ic~S but based ttpon the rates apfliic&ble as 4f the pro rata part had been included in ea~h bènefisiary's estate at the time be died, ~et again arguments could be made for granting various elections `to the trustee. Each of these various approaches has certain attractions. They all, however, lack the characteristic of simplicity and ease of administration. Bee~use it would work without putting an unreasojiable burden upon the IRS or the trustees, the AICPA decided that the best approach would `be to tax the corpus upon the death of the last beneficiary to die, based upon the facts applicable to such last member of the generation. Thus, if the last to die bad an actuarial interest of 60 percent, that percentage of the fair market value of the corpus on the date of his death would bC Included and taxed `In his estate. In th~s regard, it Is important to note thu need for the enactment of a very lfbe~~al disclaimer provi~on. The AJCPA reeommends that the Code provide that a beneficiary may be p~rzliitted to waive his income rights `at ~ny time within a two-year period commemling with the date of death of `the testator `or with the date that an bIter vivos trust is created. Such a disclaimer would result In no tar. There would `be tax neither at the date of disclaimer nor at the date of the beneficiary's subsequent death. Thus, the possibility Is reduced that the corpus wonhi be taxed at rates applicable to the wealthiest members of the generation. Wit/i, power to Invade the corpus, ta~aation of corpus bused on value at time of beneficiary's death-The trustee may have the power to invade the corpus for the `benefit of a urember of the "skipped" generation, or the beneficiar~r may have the power to demand the corpus. ~f the beneficia~y does not disclaim `his right to rpeeive the corpus pursuant to such power, the A~OPA would `have the tax on the corpus based upon rallies at the time of his de~tb. There would not be any reduction based upon e ctuarial computations unless the Invasion power is Jess than a complete power. Thus, assuming that a person has a limited power to request corpus (for example, a right to $5,000 or five percent of the corpus per ~vear), the vafue of such right would be included in his estate tax computation. If, therefore, a 45. year-old person received a `life interest and a "5 and 5" power, the AICPA would actuarl~~ly compute the value of the power pins the value of an income interest upon thel~emain1ng corpus. The tax on this amount would he based upon fair market values at the time of his death. If he actually draws lown corpus each *ear, the AICFA would imt `have thu remaining corpus s'ubjeeted to a tax based upon this power If the power is partially used, the computed amount would be reduced by the amount previously withdrawn. P)ven ili a case w~he~e thCre is more `than one member of the generation for whom there can be an Invasion, the AI~iPA would not recommend a tax until the last PAGENO="0329" 3;:t5. member Uies~ At s~~b tj1r~e, t1~e J~U~1 ~ mark~t ~ra~ would be 1zie1uaec~, and taxed in suci~ last persons' estate. ii~ other w~çle, ~fa~cts ~nd (~ireiU~1starAce8 applicable to the last sur~iv1ug n~ezn$i~' ~~u1d be twed~ fo~ the t~x e~w~putation. Au obvious exception would be those c~e~ w1ler~ ~ po,~io~z~ ~ th~ trust's corpus terminates as each "skipped" person d~es, In such a ~ th~e woi4d be a tax ox such ~ portion at the t1~e o~ termiuaUqn, More ~tberaZ cred4t8 for tax paid ea prior transfer8.-~AU iujusttce can occur if the "skipped" person dies sbortl~ after the trust i~ creat~d~. The severity of th~s problexi can be greatly reduqed, however, by tha A1~CPA propps~1 for more liberal credits for tax paid on prior tr sters~ U~or this *pii~pç~, not o~iy would a liberal ere4it be allowed for estate' tax oi~ prior trans s, but áise for gift tax paki in the case of an inter vivos trust~ (This 1o~tcatly follows as a result of the proposed integration o~ the gift an4 estate taxes.) With two "8kipped" generations, taxation based npo~ ~zct~aria1 computations.- There wouki be a tax upon the death of each member of each skipped generation based upon actuarial computations. The actuarial interest o~ a child who bad an income Interest would be taxed upon his death, Tb,e actuarial interest of a member of the next, "skipped," generation would be taxed upon that member's death. Assuming, for example, a life income to a son and then to a grandson with remainder to great grandchildren, the tax upon the death of the son would be as described above. The tax upon death of the grandchild would be based upon his age at the time his income interest vested (that 1~, at the death of the son). if the grandchild should predecease the son, there *oukt be no tax upon the grandchild'S death. If the grandtthlld dies shortly after the son, there `would be a liberal credit for the tax paid upon the son's death. VJc tension of ava~Zabl74tp of previously taaed property crelit.-rnder present law, if a gross estate includes property recently' inherited from a prior d~cedênt and the prior decedent's estate paid a tax with respect to'the property, a credit l's ayailabl,e to the second estate. A full credit is available If less than two years has elapsed between the two deaths. The credit, i's reduced by 2d percent every two years, until no credit Is available if the ~eeond death occuts more thall ten years after the first. Estate and gift tax reforms have been proposed that will generate additional tax revenue. The generation skipping proposals, in particular, can result in a tax for each generation rather than for every second or third generation, as Is presently the case with large acenmulathuis of wealtb. Because `of the greater and more frequent incidence Of tax, the' ATOPA has concluded that the previously taxed property credit should `be available for a longer period of tifl* than the present ten years. The AI(JPA favors extending the availability of the previously taxed property credit. For the first five years after death a 10(~ perce~1i credit for prior estate taxes would be granted. The percentage of the credit available wonid be reduced by fi~ve percent per year thereafter. When a period of ~ø years has elapsed, no credit would be available. Evamplc.-Assume that A dies in 1974 leaving his entire estate to B, and B dies in 1978. Il's estate will have a credit available equal to the entire estate tax paid by the estate of A, if B dies In 1984, ten years after A dies, the credit `would he rethi~ed to 7~ pcr~ cent of the taxes paid by A's estate~ that is, 100 percent less 2~ percent (fIve years at five percent). If B dies after 1999, no credit from A'a estatte would be available. The period of twenty-five years was' selected as representative of a customary period between generatIons. The gradual' reduction in credit between five and twenty-five years was considered to be logical Iiiasmueh aS the second decedent would have enjoyed the inherited ass~t~ ~or sOnic pSrlod Of thri~. Tire transfer at his death should, therefore, be at least partially taxed. This liberalization becomes logical if generation skipping Is adopted~ If a member of a "skIpped generation" die's prior to his actuarial expectancy, his estate, under the AIOPA proposals, tenet nevertheless include an actuarially computed amount. Phe liberalized credit results in fairer' treatment In such cases of premature `death. slmtMAlrr The ATC)PA Is opposed to a tax upoi~ outright generation skipping transfers because the member of the skipped generation has no econ~&nic, iut,erest in the property. Further, the AICPA finds nothing s~elal1y or eco~~mically wrong with gifts or bequests that totally skip a generation. If a person has an economic Inter- est, that interest should `be subject to a tax at the time the interest terminates. PAGENO="0330" 316' The tax should be measured by the value `of~ the pe~son's estate as well as the value of the juterest. An `additionaitax on the original settler `or on his estate is unfavorable, since this would cause an incorrect timing of the tax. Nor should taxpayers be required to make an election aS to when the tax is payable or as te when the* trust property should be valued.~ The `AI'CPA Is opposed to the IRS proposals because It does not believe that a' ñeW'ta~hould be enacted. Rather, it i~ felt that 1~he'sitnation can be corrected by redefining the criteria that will result in inClusiQus In' a gross estate or in taxable gifts. The IRS proposals may result in excessive complexity, lack of relationship of' the tax to the economic Interest subject to tax, and 1ñcôr~ect timing of the tax. There are many situations not covered in this presentation. Only a basic concept necessary to solve a basic ptoblem has been set forth. This basic problem is that~ at present, a generation may have the benefit of corpus which i.s not subject to transfer tax when it is passed on to the next generation. To subject such corpus fully to tax when the generation has only a limited interest Is, in opinion of the AICPA, `ipappropriate. The above proposals attempt to find a fair and equitable solution to a very' real problem. `The'MaritaZ'Deduet~o~ EACKG~OUND Current law allows a deduction to a donor or decedent for part of the value of property `transferred to a spouse. Such a deduction, referred to as the "marital deduction," is limited in the case of a gift to one-half of the value of the gift, and in the case of an estate. to one-half of the "adjusted gross estate." As a result of the marital `deduction, an Individual may transfer one-half of his sep- arate property to his spouse tax free. To qualify for the marital deduction, outright ownership of the property transferred generally must pass to the spouse so that, unless it~ Is consumed or again given away, it will eventually be included, in the estate of the surviving spouse. Such provision is referred to as the "terminable ~nterest rule." DISCUSSION GeneraZ `Many practitioners and professional groups believe that the present structure of `the marital deduction Works a hardship on small to" moderate-sized estates, especially those estates where all the assets are bequeathed to' a widow who must provide for herself and her children. Treasury Department studies in'dicate that a widow, on the average, survives her husband by ten years and it is felt that a tax, when property passes to a widow, imposes a difficult burden at a time when other significant income sources often disappear. ` While it is generally agreed that adequate protection for widows and a reduc- tion in estate tax on moderate estates is a necessary part of estate tax reform, there does nOt appear `to `be any reason for the dCfOrral of ~estate taxes when property transferred to a surviving spouse is more than sufficient to satisfy her' needs. A.n unlimited marital deduction, advocated by some groups, goes far heyopd~the objective of providing relief to a `surviving spouse, and would be of greater ~benefi'tto larger estates than smaller estates. Studies indicate that. the adoption of an unlimited marital deduction would result in a permanent reduction of seven percent of the revenue" from federal estate and' gift taxes'and an immediate revenue loss Of as high as 17 percent since there would be a tax deferral until suëh time as the surviving `spouse dies. Most of the other `estate `and gift tax reform"proposals would result `in an increase in revenue. Accordingly, a retention of the existing 50 percent marital deduction (with a' modification for modest estates) `would allow for an adjustment in the rate structure and' exemption level which would not be dependent on the' enactment of a provision for taxing appreciation at death. An unlimited marital deduction would. tend to distort proper estate planning. In order to minimize the tax on the first to die, there would be a tendency to~ transfer all of the property to the surviving spouse. In estates of any substance, the transfer of all property to a snrvivng spouse, particularly when there are children should not be encouraged. Under `an unlimited marital deduction, defer- tal pos~ibillttes resulting from remarriages can be carried to ludicrous extremes. Adoption of an unlimited marital deduction appears to make the adoption' PAGENO="0331" 317 of, a beneficial enjoymeuUheoxy essentiai. Under ~an uu1imit~d marital deduction, th~ beneficial enjoythéntte~t ~Onth he tiw O1~ly meau~ ~á~eallable for a decedent to have control over the uItin~ate dippo~itionq~ property and yet for such property to qualify for the marital deduction. ~i~h aprovision would be a necessity where there are dhuidteninvolvedor cm situations o~ sec~md m~r~ages ~here tl%e tax deferral opportunity tinder an un~jimited marital deduettçn wonld encourage outrighiLtransfers of all prOperty to surviving spouse's. While the adoption of `a hetiefletal enjoyment rule;wonjcl allow a~ decedent to qual1f~r property forthe marital deducUon andstil~retaincontrol over itsuithuate di~position, it Woi~kl appear that an unlimited marital deduction would still tend to enocurage the transfer of all property to a surviving spouse, Porition Of other profess'tonaZ gro~4p8 In their studies for estate and gift tax reform, the U.S ~t~re~~ury Department, the Americai~ Law Institute and the American 13anker~ ~.ssociation all propose liberalization of the current marital deduction, with respect to both amount of the deduction and the type of interest which will qualify, Recommendations of the Treasury and of the ALl propose that the present 50 percent marital deduction .be removed entirely and replaced by an unlimited 100 percent marital deduction. The ABA favors a retention of the existing 50 percent marital deduction, coupled with a deduction for the first $250,000 of property transferred to the surviving~ spouse regárdles$ of the 50 percent limitation. With respect to the type of Interest which will qualify f~r the marital deduc- tion, the Treasury, the ALl, and the ABA, in, general agj~ee that the present terminable interest rule should be eliminated an~l replaced k~ a co~icept referred to as "current beneficial enjoyment rule," whereby a mere Income interest to the surviving spouse may~ qualify for the marital deduction. tJnder the current beneficial enjoyment rule, an interest will qualify for the marital deduction whether or not the surviving spouse cQntrols the underlying property, as long us it is agreed that the property will be taxed at the death Qf the spouse, O?OSAL~ * Retention of the 50 percent eiaritaZ deduotion..'~.Tbe AI~iPA believes th4~ th~ current incidence of gist and estate taxation impose~ a disproportionate burden on small and medium-sized estates. The AICPA's unified transfer tax proposal recommends an exemption level of $150~0Q0. Assuming an exemption level of $150,000, it is felt that a 50 percent marital deduction will `provide adequate relief, for a surviving spouse in moderate~sjzed estates, Accordingly, thé"AICPA recomi~iends a, retention, of the 50 percent marital deductieq as currently provided in Sec~ 20~43, ` ` ` : Retention of thç~ ec~isting ter~'ninab~e Interest ruies.-The AIOPA ,also' recom- mends a retention of the existing terminable Interest rules Advocates of change In the existing terminable iflterest rule point ,to the complex and technical requirernents~ne~essary for a~4uterest ot~ier than out4ght ownership to qualify for the `marital deduption. The e~isti~n~ terminable interest rule has resulted in an inequity ~or ~ unaware of~j±s `restrictive prGyts~o~s, To replace stwii rule with a beneficial qpjoymen~ theory would likewise cause~ inequity~ to the unwary~ Wbjle a beneficial enjoyment rule would,allow for greater flex~bility in estate planning, Introduction into the Code of auentlrely iiewconcept permit- ting a mere: IncOme interest to qualify'for the marital dedu~tton would add add!- tional complexity to the law probably causing considerable new litigation. St~MM~RT The AIQI~A is oppo~~~ to a change In the ~federa1. estate and gift ti~x laws which would permit an nultipited marital deduction and the addition of a benefichtl enjoyment rule, While estate ~tax reform should provide aAleq~~~e prptectiöfl to a surviving spçuse In moderal~q e~tates, fhe ATORA feels that the increase in the existing exemption level to, $i50~000 horn $60~0Q0, along ~ritb retention of the existing marital deduction and terminable inter$t ruleB, w~ll aeeomplls~ such a result. A. change to an unlimited marital deduction and a beneficial en~ joytnent concept would b~ of greater benefit to larger estates, resulting in substatitial revenue loss, and addjn~ further complexity to. the existing tax laws. . . PAGENO="0332" ~318 . Appreciated A$8e~s 2~ransferred at Death, ~ BAc51~U1tOt1~D * tnder current law, the fed~taI e~tate~ ta~ 1~* irnp~ted upon th~ fa~ fr market value of~ts~~ts Inchidibie li~ the decedent's g~ros~ estate ~ietermti1~~d at the r~te of death or alternate valuation date (after talting iz~tO account allOwable deductions and credits). The basis of the p~oj~rt~ in the hands Of the recipient beneficiaries then generally beèomes its vaine for estate tax purposes. If, how~ ever, the property represents the right to "income hr respect of a decedent"- such as wages receivable after death, or obligations derived from a sale re- ported by the decedent under the installment method-the beneficiary must carry over the decedent's basis, if any, Asset appreciation is not sub)ect to income tax although it Is included in the post-death basis of the asset, undOr the general rule stated above. Appreciated property transferred by inter vivos gift normally retains the same basis IC the hands of the donee as it had In the hands of the donor, plfis gift tax paid on the full value of the transfer. The 196~ Treasury Proposals contended that the current law permits vast portions of capital gains to escape income taxation. It charged that the law fails to recognize the separate characters of estate and income taxation. It further claimed that accumulations derived from appreciation are favored over accumulations from annually assessed dividends, interest and wages. In addition, the Treasury Department also stated that "minatliral holding pat- terns" develOp because older Investors become locked into appreciated assets to avoid paying ineOthe taxes on recognized gains. The Treasury Department drew up statistical tablen based upon data gleaned from returns Of the 1960's and concluded that $15 billion a year of capital gains fall outside the income tax system. Vnder the 19~9 Treasury Proposals~ capital gain tax conCè~t, the apprecia- tion on capital assets held at death world be taxed lii the final income tax return of the decedent as if the assets had been held for more than six months and sold just prior to death. "Income in respect of a decedent" would no longer be taxed as the income is received. It too would be "bunched" into the decedent's final return and taxed as capital gain or ordinary income, depending upon itS nature. Only appreciation that accumulates after enactment of the proposals would be subject to the tar. Thus, the provlsiohs would not have retroactive effect; but establishing valuations on the enactment date would be necessary. The income tax attributable to such capital gains and `income in respect of a decedent" would be deductible from the gross estate of the decedent and would reduce the taxable estate and, accordingly, reduce the estate tax (if anyl otherwise payable. The taxed property would accjtdre a stepped-up basis in the hands of the beneficiaries as undercurrent law. Property transferred to a surviving spouse and to charity would be exempted from the tar. The decedent's basis for thO property would carry over to the spouse. Fivery decedent would have a minimum basis entItlement of $60,000 to preclude taxation below that level. All losses on capital assets held at death would be considered long-term and applied against capital gains in the year of death; then, under special rules; applied in the following order: against capital gains in the three prior years; against ordinary income for the year of death; and, lastly, against ordinary income of the three prior years. When losses are carried back, they would be applied first to the most ~recent preceding year. Only 50 percent of the capital loss would be deductible when applied against ordinary income. Any losses not applied during the four-year period would expire unused. Thuier the 1969 Treasury Proposals since appreciation on property passing to widows and charity-and to a limited extent to orphans-would not he taxed, the basis would be allocated arithmetically among the assets other than cash, in proportion to their respective fair market values. The objective of this rule would be to discourage transfers to particular beneficiaries principally to accomplish tax objectives. Income taxes generated by the foregoing proposals would be payable, along with the estate tax, under broadened tax deferral provisions. The 1969 Tree sury Pro- posals also held out the prospect of lowering transfer taxes to the extent that revenues are expected to be produced by this new capital gains tax. PAGENO="0333" 31~ nisoussiox GeneraZ Some Insight into the ratloflale ijnderlying the 1960 Trea~ury Proposals can be gained by ~ei1ect1ng upon cevtaln statements contth~ed therein, and upon a lecture given by their chle~ adVóc~ate, Professor Stanle~r S. ~nrrey. The proposals assert: "For ocZmini8tretiV~ rea~~ons the ta~ system dees not every year make tthe taxpayer wbo~e assets h~ive apprec1i~ted) calculate bow much his holdings have app~ec1ate4 in valuer" (P 382; emphasis and bracketed matter supplied.) Profess9r Suri~êy elaborated upon this theme ~uring his portion of the Third Hess Memorial Lecture delivered to the Association of the Bar of the City of New York on November 18, 1971. Among other things, he stated; "We could, and probably in equity we shonl4, ta~ gains as they accrue currently year by year. But, we don't and tbq income tax system stays its hand as the asset in- crease% in value, part~y for administrative reasons and partly for policy rea- sons, such as, for example, that money may not be at* band to pay the tax." ~ This argument could lead to the conclusion that If the admlnistrntive proce- dures could be made somewhat easier, then nothing would stand in the way of a periodic, perhaps year-by-year, tax on unrealized appreciation. Another factor is the philosophical view of the economist Gardiner Ackley, which was quoted with apparent approval by Professor Surrey during the hess Lecture, and introduced by his comment that these words do not come from a radical economist: "In my judgment the time has now come to move steadily and rapidly toward the virtual abolition of the unequal start in economic life that accrues to one who Is bern rich.,., "The vehicle is at hand `to do this in the radical revision of our estate and gift tax laws~ I should hope that within a decade or two we could place a virtual ceiling on the transmission of more than the most minimal property income from members of one generation to members of the next." (Pp. 45-6) If one starts with a predilection for the income taxation of unrealized gains and Is inclined to seek the eradication of disparities of wealth, these factors `would tend to support a tax system containing the technical complexities and burdens inherent In the capital gain tax proposals. While this report does not take a position with respect to such goals, the AI~PA feels however, that Con- gress ought to be fully aware that they may be the springboard of the 1989 Treasury Proposals. S The 1969 Treasury Proposals place great weight on statistics to stimulate Congress to action. It should also be noted, however, that the Treasury Depart- ment drafted the Proposals in the context of an active stock market, and used examples of brvestors who experienced ~O `percent a~preciatIon `in one year. Shortly after the Proposals were issued, the stock market' began a precipitous plunge. More recent statistics Indicate the probability that severe inequities could result from the arbitrary taxation of appreciation `at a date prior to the realization of capital gains. S While those In favor of a tax ~u appreciation at death often argue it elimi- nates the lock-in problem, changing economic conditions are a far stronger force to that end. We have recently witnessed significant changes in investment philosophies, and traditional practices of indefinitely, holdipg on to "blue chip" investments are now being challenged. Untouched investments in many basic industries-rails, automobiles, chemicals, basl~ metals, electronics, etc-over extended periods of time would have produced little gain and some notable financial disasters. Tomorrow's "blue chip" Investments will be different from today's, and the elemental urge to preserve capital will dWtate changes in security portfolios. S There is one type of investment, however, where a tax Op appreciation is cer- tain to unlock forcibly long-standing ownerships-small businesses. The prob- lem here Is that the unlocking process may be ruinous. The prospect of the conjunction of Income 4nd estate taxes on the value of the business would probably accelerate the trend to merge or sell out to avert forced sales when the owners of closely-held companies die. This consequence should not be over- looked by Congress when it considers the advisability of imposing a capital gain tax on appreciation. 1 Richard B. Covey. Stanley S. Surrey, David B. Westfall, `Perspectives on Sugg~sted Revisions in Pederal Estate and Gift Taxation," in The Record of the Association of the lIar of the City of New York, Vol. 28. no. 1 ~l97lI), `p. 40. AU subsequent citations of this article will be made by page number within the body of the text. PAGENO="0334" 320 The 1969 Treasury Proposals repeatedly refer to the advantages held by a taxpayer who accumulates wealth through untaxed appreciation of his capital assets over one who earns ordinary income. While there Is no doubt that one who is subject annually to a tax upon his ordjnary income is at a cthxLparative djsadvantage, that clisadirantage exists whether O~ not the investoi~ is taxed on his capital gains, because the capital gain tax iippliés only when the Investor chopses to realize the gain, aud the tax Is at lower effective rates. Probity dic- tates that the effects of current law be evaluated by .coWi*rin~ persons who are similarly situated to measure fairly the advantages that one may have over the other. The two illustrations that follow contradict the Impllc~tions of the 1969 Treas- ury Proposals that. the current law permits high~bracket taxpayers tc~ elude paying their fair share of taxes forever. They disclose that the estate tax, aSsum- ing other proposals in this Report for a unitary tax structure and for the preven- tion of generation skipping are enacted, effectively balances the tax impact in the two situations. Illustration 1 compares two taxpayers, A-i and B-i. At the beginning of a 20- year period ended by their deaths, both held $2 million worth of capital assets. During the 20 years, the assets appreciate 30 percent (compounded) every five years. A-i sells his property at five-year inte~va1s and pays the capital gain taxes. When he died, the last five years of appreciation remained untaxed. Be-i does not sell any appreciated assets, so that the appreciation arrives unreduced by income taxes into his estate. The Treasury Department's commentary indicates that under current law, B-i has enormous advantages over A-i, but it disregards the effects of the estate tax in this situation. For example, the Treasury Department states: "The estate tax will fall on both [4-i and B-i) so it is not relevant to say that [B-i] ought not to pay any income tax on his accumulation of wealth `because he pays an estate tax'." (P. 332; emphasis and bracketed matter added.) In Illustration 1, A-i, the repeatedly taxed investor would have paid or had paid by his estate cumulative taxes of $2,837,000. B-i, who avoided the capital gain tax would have paid Federal estate taxes aggregating $2,905,000-$68,000 more than A-i. IllustratIon 2 employs the same assumptions with respect to sales and growth rates except that taxpayers A~-~ and B-2 each held ~4 million worth of capital assets at the beginning of a 20-year period ending with their deaths. B-s, who leferred payment of tax until his death, and thereby obtained a ste~pcd-up basis free of income taxes, would have paid taxes a ~gregating $7,138,000', or $429,000 more than the cumulative taxes paid by A-s. The taxable estates of A-i and 4-2 would have been reduced, of course, by both the taxes paid and the appreciation on the tax money no longer available for investment. The higher estate tax brackets reached by B-i and B-2 brings the percentage of assets of the four estates paid Into the federal treasury into comparable alignment. The computations for these two illustrations are as follows: ILLUSTRATION 1 [Dollar amounts fl thousandsi . t Amount Assets Taxes paid Taxpayer A-I: Cost basis $2, 000 Aopreeiation-lst 5 yr-'-30 percent - - $600 Tax-35 percent 210 390 $210 Total 2,390 Aopreciation- 2d 5 yr- 30 percent 717 Tax- 35 percent 251 466 251 Total 2,856 Aspreciation- 3d 5 yr- 30 psrcent ~57 Tax-35 percent 300 557 300 `Total 3413 Ap~reciation-4th 5 yr-~30 percent: Not taxed, taxpayer dies 1, 024 Total ~ Federal gross estate tax ~ 2, 076 2, 076 Total 2,361 2,837 Ratios of assets and taxes paid to combined amount (percent) 45 55 PAGENO="0335" S21 ILLUSTRATION 1-Q~~tlnu~d (Dollar atnouflt~ in thousandsi Amount Assets Taxes paid Taxpayer B-4: Cost basis $2, 000 Appreciation-let 5 yr-30 percent - 600 2~6Q0 Appreciation-2d 5 yr-30 percent 780 3 ~80 Appreciation--3d 5 yr-30 percent 1,014 4,394 Appreciation-4th 5 yr-30 percent ~ 1,318 Total~~ - 5,712 Federal gross estate tax $2,905 Total 2 80~ $2~05 Ratios of assets and taxes paid to combined amount (percent) 49 51 ILLUSTRATiON 2 Taxpayer A-2: S Cost basis $4, 000 Appreciatlon-ist 5 yr-30 percent $1, 200 Tax-35 percent 780 $420 Total 4~780 Appreciatiorl-2d 5 yr-30 percent 1 434 Tax-35 percent 502 982 502 Total ------~ 5,712 Appreciation-3d 5 yr-30 percent - 1, 714 Tax-35 percent 600 1,114 600 Total 6,826 Appreciation-4th 5 yr-30 percent: not taxed, taxpayer dies 2, 048 - Total 8,874 Federal gross estate tax 5, 1d7 5, 187 Total 3,687 6,709 Ratios of assets and taxes paidto combined amount (percent) ._~_. $5 65 Taxpayer B-2: Cost basis --- 4,000 Appreciati0fl-~$t 5 yr-30 percent. 1 200 - Total 5,200 Appreciation-2d 5 yr-3D percent 1, 560 Total * 6,760 Appreciation-3d 5 Yr-30 percent 2,028 Total - 8,788 Appreciation-4th 5 yr-3D percent 2,636 _~ Total 11,424 Federal gross estate tax 7, 138 Total .~. 4, ~86 7,138 Ratios of assets and taxes paid to combined amount (percent) ~, 38 62 These illustrations assume that the taxpayer Is not married at date of death and Is therefore unable to utilize the marital deduction. In the following two supple- mentary Illustrations, the facts ~re identical except that the taxpayer takes advantage through transfering one-half of his property to his spouse, of the maximum marital deduction. Jn Supplementary Illustration 1, the tntal taxes paid by A-i and spouse (the taxpayers who recognized gains and paid the capit~ti gains tax) now exceeds by a minor amount ($2,422,000 versus $2,310,000). the estate taxes paid by B-i and PAGENO="0336" 322 spouse. flowever, in Supplementary Ithistratlon 2, the estate taxes paid by B-2 and spouse continue to exceed ($~it~4~OO vernus ~5,674,OOO) the combination of capital gains and~state taies paid by A-2 and spouse. - Assets Taxpayer Spouse Taxes paid Supplementary Il$tiftration 1: Taxpa~yerA-1 and spouse: At time of~leath Marital Total Federal gross estate tax Tofai~ Assets transferred Astetstransfened versus taxes paid (percent) Taxpayer B-I-and spouse: At time of death Marital - Total Federal gross estate tax Total Assets transferred - Assets transferred versus taxes paid (percent) - Suppleme~ary illustration 2: Taxpayer A-2 and spouse: At time of death Marital Total Federal gross estate tax Total Assets transferred - Assets transferred versus taxes paid (percent) - Taxpayer B-2 and spouse: At time of death MaritaL __~_.. TotaL Federal gross estate t4x - Total_' Assets transferred - Assets transferred versus taxes paid (percent) - $4,437,000 - $761,000 (2,218,000) $2,218,000 2,219:000 2,218,000 831,000 830,000 1,611,000 1, 388, 000 1, 388, 000 2, 422, 000 1,388,000 2, 776, 000 - 53 -~ - 47 $5, 712, 000 (2, 856, 000) $2, 856, 000 None 2, 856, 000 2, 856, 000 1, 155, 000 1, 155, 000 $2, 310, 000 1, 701, 000 1, 701, 000 2, 310, 000 1,701,000 3,042,000 60 40 $8, 874,000 ~1,522, 000 -(4,437,000) $4,437,'OOO -- 4,437, 000 4,437,000 2,076, 000 2,076,000 4, 152, 000 2, 361, 000 .2, 361, 000 5, 674, 000 2,361,000 4,722,000 45 $11, 424, 000 None (5, 712,000) $5712 000 - 5,712,000 5,712r000 2, 905, 000 2,905,000 $5f810, 000 2-807, 000 2, 807, 000 5, 810, 000 2,807,000 5, 614, 000 49 51 The AICPA believes that Professor Surrey was erroneous in these remarks concerning the present system during the Hess Lectuve: "This complete forgive- ness is totally unfair to people who have built up their estate from after-tax income, whether it derives from dividends, salary or capital gains upon which tax has already been paid. It is a complete `windfall to those who are building up their estates out of before-tax income, the l4ntawed appreciation in value" (p. 49; emphasis-added). Oertainly the terms "complete forgiveness," "complete winçlfall," and "untaxed appreciation" are grossly deceptive and do not properly describe the tax sitna- tions of the hypothetical taxpayers B-i and B-2 in the ab&ve illustrations. Position of' another professional group-the ABA In its commentary on the 1969 Treasury Proposals, the ABA contends that the capital gain tax on appreciation at death Is regressive and unfair. Large estates PAGENO="0337" 323 ~vould ha've the loi~est x~et rate 9f eaiitai gain ta~s1see the tax would be allowed as a deduction at the blgbieet 1~rauM~er tax W~aeket, At ~reser~t rnte~, T7 percent of the capital gain tax cou1~ be recouped fi~om ~the estate tax~ Wh~te~er pro- gressi~ve rate scale Is iulo~ted, :the capital gaIn tax must bite m~n'e ~eply into estates In the lower brackets. Undue coSnpiexIt~%r is amc~ther charge leveLed against the Treasury Proposals by the ABA. Complications stem from the e~ciusiou from the capital gain tax of property qualifying for the marital, charitable and orphans deductions, Such e~elusions would make the basis of any particular asset nn&rnown uati~I all assets are finally allocated amnag the beneficiaries, and seles of assets and funding of bequestS of pecuniary amounts would have long une~rtain tax ~Qnseq~ences. The ABA further psints out that the ~ ~r0asury Propo~als contain a specter of interdependent ta~ ~~mputations with multiple variables. The amount of the marital and charitable deductions depends on the capital gain tax; that tax is *depeadeflt on the amount of property qualifying for the deductions; and the estate tax depends on, and often is interwoven with, the equation in fractional share deduclion~3omputntiOflS. rThe brusque discarding by the 19G~ Treasw~y Proposals of the present deferred tax treatment of "income in respect of a decedent" in See. ~9I. is challenged b~ the ABA. The P~easury Department proposed to bunch all "income in respect of a decedent," whenever it is to be received, in the final return of the decedent, [caving the amelioration of tb~ tax co~sequence5 to the income averaging pro- visionS. The ABA points out that the proposal complicatea rather than simplifies the taxation of such income. Generally, "inoome in respect of a decedent" is not readily marketable and not readilymarketable and not readily subject to accuvate valuation. Therefore, it will necessarily be reported at values below the full amounts to be collected. The discount would be reported over the ~axne period, in the sa1n~ fashion, ae~l by the same taxpayers as under cUfrent law. Moreover, anticipatory taxation would create serious l1qui~ity problems for~tbe ectate. The ABA further points out ~that taxpayers with Identical amounts of losses would be treated differently, depending upon the existence of gains and losses in the year of death and in the three prior ye~rs. Furthermore, while losses would be allowed on lifetime gifts, they would be disallowed on transfers to related parties. The ABA rbetQrlcally asks, "To whom does one ordinarily make life- time gifts, if not to related parties?" In other areas of criticism, the ABA takes issue with the Treasury Depart- ment's proposed allowance Qf basis at the higher of actual basis or enactment date vaitie, with the minimum basis, with the absence of an exemption for life insurauce, and with the t~iggerIug of added taxes where the decedent's state of residence conforms its Income taxes to those of the federal government, The ABA shies away from ~tbe obligation to prove co~t basis, asserttng that many tax~aye~s maintain inadequate records, In relianve upon the stepped~up basis rules under the current estate tax law. The ABA orginally advocated carryover of basis as its nitornative to the present system. It reconsidered, and now is In favor of the Additional Bstut Tax (AET). Under the carryover of basis concept, the tran~feror'5 tax basis for all properties Included in the decedent's estate would carry over to the trans- feree, ~s Is the ease at Dresent when property Is trau~ferred by Inter vivos gift. The federal estate tax before state death tax credit would be added to the bases. of assOtS trdnsferred, but~limited to the extent that the fair market value of, the èstate~s assets exceed their bases. Tangible property beid'for personal use by the decedent would be allowed a step-up'of basis within the limits of $5,000 per item and $25,000 in tetaL The carryover of basis proposal `was att~actlve for the following reasons: It has proved to be operative ubder present gift tax rules; The tax burden would fall on the parties who realise income on a voluntary sale of the property, aM at a time when `funds become available to pay thetax: Death Is not the moment of realization'of Income; Carryover of basis meets the objection to the escape from Income tax of appreciation on a decedent's assets; The inequity of imposition of tax before realization' of income cannot be eliminated by averaging devIces ; and Relief measures for deferring the tax will not be necessary under the carryover of basis concept. ~et in its commentary onthe carryover of basis proposal, the ABA presented Its recommendation of the matter. 68-872-76----22 PAGENO="0338" 324 ~ ~ The ABA is ~1eep1yconcerned *ith propGsals that would require theestablish ment of historical cost basis for federal income tax purposes after prOperty passes through art estate, It contends in Its commentary, that thany people have not maintained adequate records in reliance on currentlaw which makes cost basis irrelevant when the property owner dies. The carryover of basis proposal also allows the addition of federal estate taxes to the bases of items of property. The ABA Is concerned that sales of property by the executor of art estate prior to the final determination of the estate tax liability will invoivö guesswork as to the income tax consequences of such sales and will necessitatO the filing of amended fiduciary and beneficiary income tax re- turns as a matter of burdensome routine. Further, with carryover of basis the period over which taxpayers tend to refrain from the sale of property to postpone the incidence of taxation would be indefinitely extended, thus creating a lock-in problem. The ABA also considers it manifestly unfair for estate taxes to be allocated under the carryover of basis proposal to property qualifying for the marital or charitable deductions. Yet, if certain property is to receive a basis adjustment, and other property is not, the entire process of administration would be beset by the indefiniteness of the bases of specific items. Sales soon after the date of death ~are often obligatory to pay death taxes, debts, expenses and bequests. Under the. carryover of basis proposal, the ABA con- cluded, these sales may result in substantial capital gains, and the need to pay taxes thereon may require further sai~s which in turn may add to additional capital gain taxes-a compound "mushroom" effect. In light of this Interaction, the ABA contends that the carryover of basis proposal bears a close resemblance to the capital gains tax at death ptoposal-withoüt the advantages of the latter (that is, the capital gains tax liability would reduce the estate tax). The ABA believes that a carryOver of basis rule would bring with it the practical elimination of the utilitarian pecuniary marital bequest. Draftsmen would be wary because the funding of such bequests might involve recognition of prohibitive amount~ of capital gain. Finally, If a carryover of basis rule iS enacted, the ABA envisions firm resist- ance by Oongress to meaningful transfer tax reductions. The ABA believes that the tax revenues eventually to be derivedfrom adoption of a carryover basis rule cannot be accurately measured. While the ABA favors retention of the current taxing system, it urges only as the least problem-filled alternative the adoption of the `~`Additional Estate Tax" (AET). The ABA devised the AET as an alternative to the capital gains tax after deciding to reject support for the carryover of basis concept which it had previously favored. The AET would be imposed at the fixed rate of 14~percent on net appreciation of assets upon death and upon transfers made within the two years preceding death. Property transferred earlier would take a carryover basis as under current law. The 14 percent rate was arrived at by multiplying the complement of a postulated highest transfer tax bracket (60 percent) by the highest capital gains tax rate (35 percent). The tax would apply even upon property qualifying for the marital and charitable deductions. Losses at death would not be rebated to any extOnt by the AET. The ABA con- siders that proposed reduced rate structure a sufficiept compensation for estates holding depreciated assets. Only appreciation after the enactment of the AET would be subject to tbe tax. Accordingly, the proposed rate reductions of the transfer tax to a ceiling of 410 percent would be phased In over a five-year period as the revenues generated by the AET would presumably increase. The AET is advocated by the ABA in lieu of the Treasury Proposals on three broad grounds: (1) it would be progressive, and therefore fair: (2) it would be simple because it would avoid complex refinements, and would bO collected along with the basic transfer tax: and (3) It would be constitutional because It would be an excise tax, a classification which might not apply to the capital gains tax. Each of these claimed attributes of the AET is evaluated below. PROPOSALS Retention of current Zaw.-After carefully studying each of the proposals for taxing, directly or indirectly, the unrealized appreciation of assets at death, the AICPA concluded that the objectionable features of each proposal were compelling and beyond recasting. It has further concluded that the AJOPA should not temper Its strong belief that the current law should not be aban- doned, be expressing a qualified preference for one proposed change over the others. The following discussion serves to support the AIOPA's conclusions. PAGENO="0339" 325 ~ The ABA's pr~osed. taz is ~1të4 ~*i "Additional, ~state `X'ai,'~ but It, is ~it that , ~t is an Income tax It is measw~e4~L by gains-unrealized gains-ana that Is its fundameiltal defect The ~&ICt~4 as a gen~era1 observation takes the po~i tion that the claimed advazit~gç~S of the A1~T a~ not vAlid it does not agree ~tbat the tax is fair, prog;eSSi~e, ~tznp1e, a~id eoxistittttional beyond debate The correiatson of de~h. and 9a~n.-Tbe focal point ot the problem with both the AET and the 1909 Tj~easurY f~roposa1s is their thrn from the heretofore well established principle that taxes on appreciation sbonl4 he Imposed only ~when gains are rea'ized and when cash to pay the taxes is generated The AICPA believes that the view of death as ~ moment of realization of gain is philosophically unsourni Paper profits at any point in time are so ephemeral that, if they are to be tazed, only a~i Immensely complex system involving alternate valuation dates liberal tax de~erra1s credits, averaging ~nd quick i~efn±id pro cedures could posstbiypi?~vide ~or fairness. Double tao' -The AET would be in effect a iloi~ble tax This is a~know1edged by the ABA No deductiOn would be allowed for the basic estate tax for AET purposes The resultant double tax is embraced by the ABA so that the AET would be progressive when viewed in combination with the basic estate tax Rate of taw.-Tbe AIDT would not be on a graduated scale, yet it is labeled `progressive by the AI3A It Is not convincing to contend that the AET is progressive when (but only when) it is combined with the basic estate tax rate schedule. It is obv4ons that a taxpayer who has accumulat~d a modest amount of taxable appreciation Over many years would be taxed at the same rate as one who has accumulated substantial appreciation over a short term period. By contrast, the income tax rules do ease the burden upon lower bracket taxpayers In addition t~ae inclusion of only one-half of net long term gain in taxable income the exemption from the minimum tax, and the income averaging provisions operate in favor of the indivId~!iâl who recognizes rela tively small amounts of gain onan annuaLbasis. The AET rate would be tied directly to the highest capital g~Iu tax rates There have been many proposals to increase Or otherwise modify the capital gains tax If the tax Is increased, as it has been In recent years, it has been assumed that an increase in the rate of the AE~ would follow Such a change would magnify the problems associated with the AET, not the least of which would be the liquidity crisis in prospect for estates. Basis probiems.-The ABA is concerned with the requirement, especially under the carryover of basis proposal to prove actual cast ba~Is The AICPA does not share that concern-at least not to an extent that would lustify so complicating the estate tax structure The currept recordkeeping ~~eqtt1rements should be observed by all taxpayers and no taxpayer should be entitled to ignore these requirements based on the highly speculative assumption that be will bold his property until his death. The ABA s concern with proof of basis however, does not extend to several areas in which carryoverrcEE~ baa~S is adopted under the AET Per example there is apparently no concern with the present gift tax basis rules Nevertheless to avoid proof of )asis it proposes to adopt a .stkrt-up date rule. The AICPA Sees a serious problem in the choice of fair market value on the enactment date as the basis of property for AET purposes. The enactment date rule would create a natiouwide appraisal obligation which would be a substantial administrative burden Estates are not neces ~arily made up prix~aariiy of listed securitie$, and the valuation problems at the time of death could be enormous Disputes between examining agents and taxpayers' representatives often involve the valuation of real estate partr~er ship intere~ts closely held corporations loans receivable copyrights and patents valuable art work large blocks of securities and present and future interests in trusts These disputes often reach the courts A start-up 4ate would bring another set of sul4ective valuations into tha transfer tax picture, and the AUJPA believes that the accompar~ying distortions and Inaccuracies would be an unfortunate consequence of this approach Moreover the development of self serving records to support valuations for the types of assets listed above could become a widespread practice The prospects of an Informed and fair review of the accuracy of these records would likely be inversely proportional to the interval between their preparation and review If a start-up date is adopted, enormous numbers of persons will be obliged to price an inconceivably large number of assets Relatively few estates now must tile federal estate tax returns because of the exemption under current low Con rsequently, the assets of relatively few estates undergo professional appraisal. PAGENO="0340" 326 J~t ~t is diiflcu1t~-U~ pot ii~po~sib1e~-4or a , tnxpayer to know that h~ will not ~iave a taxable estate in the Uncertain fttnre He therefore cannot ~afe1y as sume that lie need not det~m1ne his start tip date values Under ti~ese conch t~QnS, t1~e appraisal o1~ property as o~ tI~e start up date would be an Immediate major burden, and valuation controversies in the settlement of estate tax ilabili ties would be mai~y times more j~recjnent tha~i Is presehtly the case Mc~r~aZ ~nd char~tab~e deduction8 -The AI1iT makes ~o a11owa~ice for trans ~ers that qualify jor tI'e marital and char~tab1e deductions In connection with the :LQO percent marital deduction propQsal the 1969 Ticasury Proposals apprQpriately state ; "It does not appear, then, that tj~a~sfer of property be- tween husband wife are appropriate occasions for imposing tax An e~pecially di~flcult burden u~ay be im~o~ed by the tax when property passes to a widow, particularly if there are minor children. The present system of taxing transfers between spouses does not accord wIth common understanding of most husbands and wives that the property they have accumulated is `ours'," (i', 358) This view should be coippared' with the ABA'S view that "As a matter of theory, imposition of a tax op appreciation should not turn upon the destination or use of the appreciation." As a matter of practice and public policy, the mari- tal deduction has been allowed in valid recognition of the nature of the marital relationship and to equate the tax consequences of taxpayers living in juris- dictions having different property law concepts. Moreover, deductions for Income tax purposes gener~1ly have been allowed for the ~talue of assets transferred to eha~ity, and no gain need be reported If the transferred assets have appre elated, The ABA's oyerridjpg consideration In suggesting these tax provisions is revealed In the toijon ing statement Further, if exemptions ii om the AWl based ppon the re~lpiepts of the property subjected to the tax or adjustments to It are introduced simplicity ss lost ahd administration becomes complex It is time tkat simplicity and ease of administration, wketlier it works `for' or `a~ainsl' tl~e taq,paycr, be considered as priority objectives in ike enactment of tas' laws." `(p. 2-4~, 44 Emphasis supplied) If we substitute for the w9rds for and against in the forego~pg quotation the words equitably and `Inequitably -or fairly' and unfairly' -the con sequence of the selection of simplicity as the overriding priority may be more clearly apparent. Finnjilsc,tty and nut an-ness-the eorrelatives -Although the AET conceivably could be modified to achieve greater equity, the ABA apparently prefers not to do this on the g~oun~~ of an overriding need for simplicity The following observations seem appropriate in this connection: Appyeciation would be taxed but there would be no tax rebate for a net loss at death. The ipvestor may have paid capital gains taxes throughout his life, but no carryback of a net loss position would be available, and no transfer tax reduction is suggested. The ABA suggests. that the investor would have some relief with its proposed lower tax rate schedule. The ATOPA believes that in an effort to simplify this proposal the fundamental Income tax character of the AWl? is ignored, and thus, the normal Income tax equitable safeguards are omitted, The AET is at a flat rate. A' graduated rate, providing lower rates for insub- stantial anloPpts of appreciation, is rejected-in the interest of SImplicity.' Properties qpalifyizjg for the marital apd charitable deductions are subjected to the AET-in the Interest of simplicity. The AET proposal incorporates a mandatory start up date basis rule al though the ABA recognizes that Inequities would occur between and among Individuals, that there would be advantages for taxpayers holding highly appre- elated property at the enactment date, and that there would be hardship for * taxpayers who have a provable basis for property greater than its value on that date-in the interest of simplicity. Tangible personal property generally is exempted from the AET; neither gain nor loss would be considered; and no dollar ceiling would be imposed upon the exemption, even though inequities could result-in the interest of simplicity Constitutionality.-Tbe ABA states that the capital gain tax on net unrealized appreciation at death has been attacked as unconstitutional. It further asserts: "Any problem in this regard in `avoided by the `ART, which Is an excise tax as contrasted to an income tax." Regarding the nature of its proposed ta'x, the, ABA admits: "Some people will say that the ART is nothing more than a capital gains tax at death. They are obviously correct in the sense that the result is the same- the taxat~op of net unrealized appreciation at death." In view of the foregoing, a layman might wonder why an ART at death should be `considered any more or PAGENO="0341" less co~isti~tutiomt1 than a cái~ttiU ~a1rt ta~ at de~th. Wottld not the cOtirts, In evaluating the coustItutionnl~t~r of the ~ look haM at the acitno~vI~dged s1mi~ larity of the res~tt, and ~ot beufldttl~r swayed by the label "excise ta±~ StMMART The ~ropnsals thfit would pnrportedly preret~t an~ ta~ reduction opportunities under the current system ace melangeS of complexitien and ineqtiiti~s bound to cause extreme di~cu1tles fo± taxpayers and goverlunent alike. If there is merit to the positions of both the 19~9 Treasury P~rop~sals and the ABA that proof of ac- tual basis over the ~r~ars ~onld be a hardsh1~, then 4arryGrer of basis is iniprac- tical and, as a matter of equity, we should then resort to a new start~ttp basis under any new taSdng proposal. If, bowever~ there is-as the AICPA contends-P a host of inherent inequities in. the new start-up basis, then it should be rejected. It is believed also that the notion that the occasioti of death is an appropriate tune for the. recognition of unrealized gain is unsound and that it should not be acceptable to Congress. The asserted imperatives for a change of current law are not obsotutely coin- pelling. It is at least debatable that a shift of problems from one tax system (for example, the income tax system) to another (for example, the estate tax system) is progress. Estates which pay as much ta~ as did our Illustrative tax- payers B-i and ~-8 on pages 820 and 821 do not escape the taxing system. Furthermore, there shotild be no extensive opportunities for transfer tax avoid- ance if the AIOrA's other recommendations-a unified transfer tax; restric- tions on generation skipping; and rejection of an increased marital deduction- are adopted. The present rules do not confuse the separate roles of the income and estate taxes. The estate tax complements the income tax. The estate tax is equitably progressive; at least, it has such high rates that Congress should con- tinue to permit the beneficiaries to take basis equal to the full values subject to such heavy tax assessments. The AIC?A knows and experienced practitionerh wjll attest that the present system is workable. The ease of reference to finally-determined estate tax values to prove the bases of assets subsequently sold is nia~lfest. If simplicity of adminis- tration of the tax law has merit, as is so often asserted by members of Congress and professional groups, the AICPA believes that where the law has this attribute with respect to taxation at death, it should not be discarded. A practical and equitable exchange of a tax on appreciation cannot be made for an appreciable rate reduction. A new start-up date necessitates a phase-in of any rate reduction, as is apparent in the AET proposal. The new start-up date also requires speculation as to the amount of tax which ~woi~1d be derived from ap~ predation over the years ahead as shown by the previous discussion of the tips and downs of the securities markets. Congress would have to gamble that appre- ciation durfng that period would be enough tO permit a considerably lower top ta~ bracket. Mereover, whatever the rate concessions m~gbt be~ these intended bene~ fits might be more than counterbalanced by the new proposed tax system to which estates would be subject. Reasonable opportunities for rate reduction exist in the AICP~'s several other recommendations. Unified Transfer Tas' Current law imposes an estate tax ~n certalti transfers at death and a gift tax on certain transfers during life. ~ach tax has a separate rate echedule with the gift tax rates representing three-quarters of the estate tax rates ~t compar- able levels. The estate tax exemption Is $60,000 while the gift tax has ~ lifetime exemption of $80,000 f~r each donor arid an ámial exclusion of $8,000 for gifts of present interests to each of any number of donees. The gift tax is imposed on the value of the gift but the gift tax itself Is not treated as an additional transfer subject to tgx. Tinder the estate tax law, the tax Itself is subjected to tax because the estate tax is imposed oil the gross estate redticed only by deductions and not b~ the estate tax. Statistics repeatedly issued by the Treasury indicate that despite the sub- stantial tax incentives ~or lifetime giving, only a ~maIi percentage of indiv1dual~ for whom estate tax returns are filed mako such gifts in amounts exceeding the lifetime gift exemption and the annual gift tax exclusions. General The primary policy question lnlroled in determIning whether there shotild be a single rate structure applicable to lifetime transfers aud to transfers at death PAGENO="0342" 328 is the exlent to which li~etime giving shoiM be encouraged. The general consensus appears t~ be that. suebgiying should beenéourage4 because it Is~oc1al1y desirable to have proj~erty transferred to or for t~i[e benefit o± y~unger generations where' there is usually a greater need and a greater willingness tO make the property productive. Thus, the Issue becomes whether the present dual rate structure strikes' a proper balance between creating iz~centives tor lifetime giving and being fair between and among different taxp~tyers. The 1969 Treasury Proposals take the position that current law grants an undue preference to lifetirn~ gifts because it benefits the relatively wealthy In- dividual who can afford to make significant lifetime gifts compared to the less well-to-do individual who cannot afford to do so. Position of other profe~sionai groups The ABA. favors a single rate structure for all transfers, whether made during life or at' death. The Ai~A's acceptance of a single rate structure Is subject to the qualification that the rates will be `lowered to offset the additional transfer taxes that will be,paya'ble at death by persons who make taxable transfers during life. "Gro'ss~pg up" the amount of lifetime gifts to be Included in a single rate structure for all transfers has also been prOposed. This concept has been ex~ plained to require that the single-rate-schedule transfer tax would be imposed upon the ~air market value of the property transferred, including, in the case of lifetime transfers, which Is an integral part of the making of the gift. Under' present law, the tax on lifetime gifts is based on the fair market value of the property transferred exclusive of any gift tax. In the case of testamentary transfers, however, the present estate tax is imposed on the full value of the property, in the estate, including that portion used to pay the estate tax lmposed~ Under the unified transfer tax, this difference in treatment between lifetime gifts and testamentary transfers would be eli~ninated. by "grossing up" the fair market' value of lifetime gifts, thus causing the transfer tax in effect to be paid out of the property taxed, as is the case with testamentary transfers. A table would be provided showing the amount of the grossed-up transfer so that taxpayers would not beburdened with complex calculations. The ABA opposes the use' of "grossing up" for all lifetime transfers on two grounds. First, it discourages lifetime gifts because the payment of the additional transfer tax Imposed on the tax results in the loss of subsequent earnings on that' amount during the remaining life of the transferor. Second, it Is complicated and~ would not be understood `by `transferors, particularly when, as is possible, the tax: is greater than the `amount `of the `gift itself. A majority of the members comprising various' bodies within the ALl appear' to prefer,a unified transfer tax, In October 1967, however, the council of the ALl voted 12 to 11 in'favor of the retentiOn of the dual tax system. At the present time, there appears to be no official ALT recommendation `on the choice betweei~ a dual tax system `and a unified tax system. The ALT does appear to favor "grossing up" all lifetime tratafers ~nd the retentioti of the present $3,000 annual gift tax exclusions. 1'I~0?O5ALS Since lifetime transfers should continue to be encouraged and further, since the current incidence of taxation o'n testathentary dispositions is imposed dis-' proportionately and unfairly on low and medium-sized estates, the AICPA pro- poses a modified unified `transfer tax `as follows: Retention of current estate tas' rates.-The modified unified transfer tax would utilize the federal estate tax rates as currently established `by. Sec. 2001 of the Code. Along with this the AICPA advocates continuation of the current Incentive to make inter vivos gifts by subjecting such gifts to a tax at the rate of 75 percent of that rate. Inclusion of lifetime gifts.-Lifetime gifts would be Included In the unified rate without "grossing-up" lifetime dispositions except for gifts in contemplation of death, The 75 percent rate would be preserved at death by the inclusion of only 75 percent of the taxable value of property transferred during lifetime and by the granting of credit against the unified transfer tax liability for gift taxes paid on such taxable gifts. Gifts In contemplation of death, as that term is currently defined by See. 2035, would be "grossed up" so that `both the value of the property at the date of death and the amount of gift tax paid would be subject to the unified transfer tax `at death. Credit would be granted against the unified transfer tax: liability for gift taxes paid on gifts made in contemplation of death. Annual ea~clusion for glfts.-The AIOPA advocates the continuation of the `$3,000 annual exclusion for gifts of present Interests in property as currently provided by Sec. 2503(b). PAGENO="0343" 329 Untifled transfer tan, déd Uàn.-4F~or the ~fi~tei~t' estate ta± e~mptlon In the amount of $60,000 provided by Sec. 2052, and the current specific gift tax exemp- tion in the amount of $60,000, provided by Sec. 2052, and the current specific gift tax exemption 1pJ~he au~ouflt pf $30,000, provided i~ `See. ~521, tlie'AIOPA would substitute a ~tn1fied transfer tax deduction In the amount of $150,000, av~tliable, at the option, of the taxpayer, either against inter vivos gift tax liabilities or against the unified tran~fer tax jmpos~d at death. ketention of nuvritai EJeduo2~ion.-The AIOPA proposes the retention of the allowance of a ina~ita1 `deduction as currently provided by `Sec. 2056. BVMMARY The AICP.& believes that the recommendations ontlined above will continue to encourage lifetime gifts. The continuation of the 75 percent gift tax rates, the aval1a~bility of annual gift tax exclusions, the continuing possibility of removing asset appreciation from an estate by eliminating from the death transfer tax a~preclation from the date of the gift to the date of death, and the income thx considerations often associated with Inter vivos transfers can' all~ be cited as continuing reasons to support inter vivos gift transfers. The current estate exemption of $00000 and the current specific gift tax exemption of $30,000 are inadequate when considered in light `of many years' inflation. Accordingly, the AICPA recommends `that the current tax exemptions be replaced by a unified transfer tax deduction of $150,000, available to a tax- payer to reduce either the amounts of Inter vivos taxable gifts or to reduce the taxable estat~~ Also recommended is the continuation of the two present transfer ta~ schedules' since the availability of two schedules does not create undue administrative problems. The "gross~up" concept for inter vivos transfers is opposed prirnarily because sub'c a provision would discourage lifetime gifts. The "gross-up" concept also appears' to be extremely complex in administration. The following Sebedule~ A, B andO (pp. 330-331) Illustrate the AICPA recom- mendations to retain the current rates, to retain the currrent concept of a marital deduction, and to substitute a unified transfer tax deduction in the amount of' $150,000 for the current $60,000 and $30,000 estate and gift tax exemptions. The AICPA believes that these recommendations, when combined with its other rec- ommendations, including our recommendation for severe restrictions on genera- tion skipping, will not adversely affect the total federal revenues derived from these sources. instead, these recommendations should alleviate substantial in-" equities currently Imposed on low and medium-sized estates, It is noteworthy in the* following schedules that total transfer taxes from `an' estate with net' dis- posable assets aggregating $200,000 would be decreased from $36,100 to $7,000, while for larger estateg, `total transfer taxes would not be slgnlficaittl~ affected. Equally important should be the fact that In the typical situation where the male predeceases the female, imo death transfer taxes would be, payable at. the death of the first decedent until net disposable assets exceed $300,000 where the sur- viving spouse inherits all of the family's assets, Since the necessities of life often dictate that In low and medium-sized estates the surviving spouse `requires all `of the famIly's assets, the `AIOPA propohed tax structure should permit and strongly' encourage such testamentary dIspo~ltions by Imposing the major portion of death transfer tax `liability only at the time'of death of the second spouse. ~chedu1e ~ (p~ 330) Illn~trates the effect of Inter vivos gifts (other than gifta In contemplation of death) by the first decedent. Note that substantial savings In total federal unified transfer taxes can be realized by ~the continued use of Inter vivos gifts; such savings are increased where the unified transfer tax deduc- tiort of $150,000 is not claimed against earlier gifts taxed at low gift tax rates. ~chedtile D (P. 381) ~ummarizes the computations In Schedules A, B and C. Assume, for these schedules, that: 1. Pecedents with net disposal assets of $200,000 or less transfer their total est~ te to a surviving spouse. Such second estates are reduced only by federal estate taxes Imposed at the first death. 2. Pecedents with net disposable assets of ~1,000,00Q or more utilize a full marital deduction and limit testamentary dispositions to a spouse to such amount. 3. Assets transferred at the death of the first decedent neither appreciate nor depreciate In value between the date of transfer and the date of death of the' second spouse. 4. Credit for state death taxes are disregarded for the purpose of these com- putation's since they effectively represent a substitution for such death taves. 5. Annual exclusions are disregarded in determining Inter vivos gifts in Sehed- ule C. PAGENO="0344" 330 SCHEDULE A: CURRENT FEDERAL ESTATE TAXES-NO INTER VIVOS GIFTS 1st death: Net disposable assets (after feduotion by liabilities and expenses)4 $200000 $1, 000,000 $5,000,000 $10, 000, 000 less: Marital deduction - 100, 000 500., OQO 2, 500, 000 5, 000~ 000 Exemption 60,000 60,000 60,000 60,000 Total reductions 160,000 5613,000 2, p00, 000 5~ 060,000 Taxable estate 40, 000 440, 000 2, 440, 000 4, 940, 000 Federal estate tax 4, 800 126, 500 968, 800 2, 430, 400 2ddeath: Net disposable assets 105, 200 500, 000 2, 5013, 000 5, 000, 000 Less exemption 60,000 60, 000 60,000 60, 000 Taxable estate 135 200 440 000 2 440 000 4 940 000 Federal estate tax 31, 300 126, 500 968, 800 2, 430, 400 Summary: Total Federal estate taxes 36, 100253, 000 1, 937, 600 4, 860, 800 Tax as percent of total net disposal assets 18. 1 25. 3 38. 8 48. 6 SCHEDULE B: PROPOSED FEDERAL UNIFIED TRANSFER TAX-NO INTER VIVOS GIFTS 1st death: Net disposable assets (after reduction ny liabilities and expenses) $200, 000 $1, 000, 000 $5,000, 000 10, 000, 000 Less: Marital dech~otion. 100, 000 500, 000 2, 500, 000 5, 000, 000 Unified transfer tax deduction 150,000 150, 000 150, 000 150, 000 Total reductions 250, 000 650, 000 2, 650, 000 5, 150, 000 Taxable estate None 350, 000 2, 350, 000 4, 850, 000 Federal estate tax None 97, 700 924, 700 2, 373,700 2d death: Net disposable assets 200, 000 500, 00~l 2, 500, 000 5,000, 000 Less undied transfertax deduction 150, 000 150, 000 150, 000 150, 000 Taxable estate 50, 000 350, 000 2, 350, 000 4,850,000 Federal estate tax 7, 000 97, 700 924, 700 2, 373,700 Sumpiary: Total Federal estate taxes 7,000 195, 400 1, 849, 400 4, 747, 400 Taxes percent of total netdisposal assets ____ 3. 5 13. 5 27.0 47. 5 SCHEOULE C: I~ROPOSED FEDERAL UNIFIED TRANSFER TAX-WITH INTER VIVOS~0IFTS Net disposable assets $200,000 $1, 000, 000 $5, 000, 000 $10, 000,000 Inter vivos gifts by 1st çlecedent of 20 percent of net disposable assets (not in contemplation of death)- except in case of $200,000 estdte None 200,000 1,000, 000 2,000, 000 Lessunified trpnsfer tax deduction None (None (None (*Ione cl~rpied) claime~l) ~laimpd) Taxable gifts ~_ None 200,000 1,1300, 000 2,000,000 Federal gifttox 38, 000 244, 300 584,000 1st death: Net disposable asseta (reduced by amounts of gifts and gift taxes) `200, 000 762, 0130 3, 765,700 7, 435, 100 PIus: 75 percent of inter vivos gifts None 150, 000 750,000 1, 500, 000 AsSet balance - - 200, 000 912, 000 4, 505, 700 8, 935, 100 Less: 50-percent marital deduction 100, 000 456, 000 2, 252, 850 4, 467, 550 `Unifleti transter tax deduction not `p?evioi~sly claimed 150,000 150,000 150,000 150,000 Total deductions 250, 000 606, 000 2, 402 850 4, 617, 550 Taxable estate None 308, 000 2102, 850 4,317,550 Federal e4tate tax None 83 600 803 600 2 038 300 Less crodit'for gift tax paid None ~8, 000 244, 300 564,000 None 45,600 559,300 1,473,400 Net Federal estate tax ~_ PAGENO="0345" 331 SCHEDULE C PROl~OS~ElY FED~RA18 UMIFI'EO T~X~-.Wrfl4 l0~t~R~ VIVOS GIF1FS--..Contthued 2ddeath~ Netdisp53able~assets $200 000; I~essrunifIed,transfer tax~decFuction~ 15G~ 000 Tax~bleestate ~ 000 FedeyaIiesM~tm5i.. 7~ 000 Summary: Total Federal unified transfer taxes 7, 000 Tax as percent of total net disposable assets - 3. 5 $450~ 000; 15000ff; $21 252, 850 $4, 487, 550 150d000 150, 000 308 000 821 600; 167, 200 2, 1021 850 4, 317,550 803,;600 2, 088, 300 1, 607, 200 4, 076, 600 16. 7 32.1 40. 8 $CH~E0Ul~E D: SUMMARY Net,disposablë assets (after reduction by liabilities and expenses)' $200, 000 Totalimarent lTed atestate;texes (no i4tter~vivos~giftS)- Schedule A $36,100 Total~tax as percent of net disposal assets 18. 1 T~alproposed' Pecteyal'ut,ifl'ed t~ansfer' thnes-(no inter' vivos gifts)--Schedule B $7, 000 Total tax as percent of net disposable assets 3. 5 TotatpropnredWeral~uni1led'trx55fnrte)c5S after Inter vivos; gifts of 20 percent of net disposable assets- Schedule C NA TotaLtaxtas percentof total net disposable assets' N'A $1,000,000; $153,000' 25 3 $195, 400 19. 5 $167, 200 16.7 $5 000, 000 $10, 000, 000 $1,932~5Q0 $4,860,800 38.8 48 6 $1,,8401 400 $4; 747,400 37. 0 47. 5 $1, 607, 200 $4, 076, 600 3'1~ 1: 40.8 NA-Not applicable. Liberalization of Deferred Payment' of Federal E~state Taa~ BaCBuRO!~ND Sec. 616t1'was enacted by Congr~ssln 1958. The house Committee Report accosit- pa~ying H.IL 8381, w]$oh added See. 616(3 to the 1954~ Coder provided, that where the value of an Interest in a closely-held business represents a significant portion `of tile base on which the federal estate tax is computed, the fed~ral' death tax can be paid ils ten annual lñsta'llm~n'ts instead of ~ lttmp~sum payment 1~ months aftet the death' of the d~n~dent. For pu~pos0~ of See. 6160 a olciSely-beld ishie~sa includes a proprietorship, or stock or interest ownership in a partnership or corpo~atlon ot'2G percent or more, or a partnershl~ or eoi~o~at1on in~ Which th~te are 1G. or feWer partners or sha'reholders~ The E~ase C~i0niilttee `Report explained the ~urpOse was to makO. it possible to keep together a business enterprise where the death of one of the larger `owners of th~ business results in the Imposition of a relttttvel~ heavy estate tax. Fnder' exinting' 1kw, *h~s a~ decedOnt bas~ a substantial portion of his estate Invested in the business enterprise, the heirs might bo~ confronted with the neces- sity of either breaking up the business or selling it to larger enterprise, in order to, obtain funds to pay the federal. estate tax. This Is especially unfortunate in the case of small b~s~iles~es,, which tradltlonafl~r are also closely-held businesses. By spre,adlng out' tile ~eriód. over which the estate tax may be paid, it would be possible for the estate tttx to be paid" out of the earnings of the business, or at least It would provhIE~ tile b~1l~s wIth time to obtain funds with, which to pay the tax without' u~settlng the operation of the business. This provi'ston was believed to be particularly Important in proventiiig corporate merg~s and in maintaining tile tree' enterprise systen~. Sec. 6166' was deemed necessary because the g~eral provision of Sec. 6161 (a) (1) permitting a six-month extensloit of' time for payment of federal taxes, In- `eluding federal estate taxes `by the Ilt~ for reason'kble cause, Is not an adequate remedy for an executor holding an Interest lit a closely-held business. Sec. 6161 (a) (2), whIch permits the 1115 to grant an extension of tIme for up to ten years 1ir'pa~'metIt of'esinte taxes upOn a showlng'that payment of the entire estate tax `would result in `~undtse hardshlp"to the estate, Is also an Inadequate relief pro- cedure for an exeentor ho1~ltng an Interest in ~ closely-held bu~iness. For dO- `cedents d~'1ng after l!~ecefirber 31, 1~7O~ wit extension of time under Sec. 0161(a) (1) can be granted for up to a year (for reasonable cause). See. 6165 permits the PAGENO="0346" 332 IRS to require that a bond (for up to twice the amount of tax involved) be furnished where an extension of time for payment Is granted. The regulations permit IRS to require such a bond when an extension Is granted under 6161. The bond requirement has not been applied In connection with Sec. 6166 extensions. Where applicable. (Sec. 303 presently permits redemption of stock of closely- held corporatiOns, to the extent of the entire amount of estate taxes, administra- tion expenses and funeral expenslons. If there Is a profit on the redemption (that Is, if the sales price exceeds the estate tax value), the profit Is taxed as .a capital gain. * DISCUSSION Generc2 S Reference to the amount of the estate taxes, federal and state, payable at death, Indicates that the executor of the estatO of a deceased owner of a closely-held business interest is faced with a substantial liability for estate taxes. The growth of the value of such an Interest during the lifetime of the owner, increases the potential estate tax burden. The greater the grostth the greater the likelihood that the executors will have to sell the closely-held business interest. Inflation serves further to aggravate this problem. S The following chart Indicates the estate tax liability of a decedent resident of New York State: Estate before exemption Federal tax . New York tax Percent on S Xcess Total Federal New York $300,000 $500,000 $700,000 $1,060,000 $2,060,000 `$3,060,000 $4,060,000 $5,060,000 $6,060,000......... - $59, 100 116, 500 176,700 289, 140 649,280 1, 075, 920 1, 551, 560 2, 069, 880 2,620,200 $10, 000 20, 000 32000 58, 800 153, 000 267, 200 401, 400 551, 600 710, 600 $69, 100 136, 500 208,700 347, 940 *. 802, 280 1, 343, 120 1, 952, 960 2, 620, 880 3,330,800 26.2 28.0 30.2 3k 4 41.8 47.2 52. 6 55. 8 58.0 5 6 7 8 10 12 14 15 16 The owner of a eubstantial equity in a closely-held bustnes~ needs statutory help, which would permit deferred payment of these substantial tax liabilities. The very size of the tax in relation to the estate should be enough "hardship" to permit relief without the necessity of proving "undue hardship" as presently required by Sec. 6161(a) (2). 5 The approach of Sec. 6166 in permitting an absolute, right for installment payments over a ten-year period of federal estate tax attributable to taxation of closely-held business interest5 should be extended to provide relief In more instances. S Where there are several closely-held business qqulties .Ini an estate, the yardstick of See, 303 and Sec. 6166 to treat them as one interest should be alike.. S Position of other professlonaZ groups Section VIII of the 1969 Treasury Proposals, "Estate and ~llft Tax Proposals," ~contained recommendations for liberalization of the Sec. 6166 paythent rules. The proposals indicate that the "voting stock" requirement should be eliminated and that the shareholder limit should be ratsed from ten to 15. Purther proposed liberalization would include permitting the installment-payment election (Sec. 6166) where the interest in the closely-held bn~ines~ exceeds 25 percent of the taxable estate. The Treasury proposals would then limit the application of Sec. 303 to `the portion of the .estate tax. which could qualify under Sec. 6166. The ABA, in its "Summary of Transfer Act Draft Statute of the. American Bankers Association" would permit deferral under Sec. 6166 where the `decedent'~ Interest in a closely-held bustness exceeds 20 percent of his transfers at death. The definition of ~losely-he1d stock would include any stock not traded on a national securities exchange or In an over-the-counter market, or If so traded, If the "estate" includes 20 percent or more of the voting stock. In the ~case of partnerships, the required' percentage of partnership interest would be reduced from 20 to ten, and the limitation on partners would be Increased from ten to 20. PAGENO="0347" 333 ~i'~Q~OSALS ~ Sec. ~3O3 ruZe8 reg~rU~~ treatment of se'verzl.~YZo8Ø~ifrhe'1d bu~ines8 equitie8 a8 ~me ehouci ta;ke ofl~ the Standard8 of &~o $~66 Sec 303 presently permits two (o~ more) corporatiOns to be treated as a single corporation where an estate owns more than 75 percent in ~aIue of the ~outstandtng stock In each M the ~orporattofls. ~ Section 6166~ has a similar provision, except that the ownership requirement is more than 50 percemt of the ~ stock. The AJCPA ~~ecommends that this percentage test $ the same for pur- poses o~ Seçs~ 303 and 61~6, and that the ~O ~perc~nt or Zuore test, of Sectio~i ~6166 apply for purposes of Sees. 308 and 6166. ~ ~ ~ Period for Sec. 303 redemption should recognize Utij7aflon in any cettrt.-The period during which Sec 303 may be utilized is the period of limitations for assessment of federal esttite tkx plus 90 days or, If a p~tit1on for redetermina tion of an estate tax deficiency has been filed with the Tax Court, at any time before the expiration of 60 days ~after the decision of the Tax Court becomes final. The AICPA feels that there Is no reason that taxpayers whO litigate in the District Court or Court of Olaims should be prejudiced, and the AICPA. recommends that..the period during which See. 803 may be applied be extended to the expiration of 90 days after the conclusion of Utigatiou with regard to the estate tax liability. Elimination of voting stock requirement of See. 6166 dud Ike raisind of the shareholder limit.-These AICPA propbsals are In agreement with those, set forth bythe Treasury DepartmeTit. Reductions in pereentdge ownership of stock requirements in SeOS 303 and 6166.-This Is In agreement with the ABA's proposal. The AICPA favors these reductions In percentage ownership of stock requirements to 20 percent (of transfers at death). It is also felt that* Sec. 6106' ~hOuld be as available to partners as it Its to~stockholders. The purpose of Sec. 6166 Is to provide additional time to pay estate. taxes where the fieceased's assets are not readily convertible to cash bece.use such assets consist of an interest in a closely held business In these lnstance~ an estate which includes a minority interest in a business may be less able to cause a redemption by the business of that interest than a holder of a large interest Therefore, some holders are in great need of the benefit of Section 6166 The problem with respect to liquidity of partnership interest is similar to that of the liquidity of a stockholder Interest and should lie subject to the same rules. Retention of See 303 (a) -In opposition to the 1969 Treasury proposals the AICPA does not feel that Sec. 803 should be restriCted to the estate taxes attrib- utable to the Inclusion of a elosely held business In the gross estate Sec 303 is presently broader In that It permits flexibility In annual reporting of estate taxes as well as administrative expenses. The narrowing of Sec. 303 would tin- pOse a serious llqnidlty hardship on estates which have to incur a substantial lpcOme tax liability in order to pay the estate taxes. Eliminate "undue" r ii~'ement of hardship situatlons.-See. 6161(a) (2) should be revised to eliminate the word "undue" from the phrase "undue hard~ ship The use of the word `undue has In effect nullified the valuO of the pro vision because of the admlntstratlv9 problems of determining what hardShIp Is "undue" hardshii~ Section 6166 should apply tO partner In a manner sinvilait to `stocklvolders.-See. 6166 relief should be as available to partners as to stockholders Conformity of Sees 301 and ~166 -The Sec 303 and Sec~ 6166 rules regarding the treatment of several closely held business equities should be conformed Eliminate Sec. 3d3's ecoteñsion re8trlction to *2~a~r Court cases.-A ~See. 303 redemption should be permitted after the conclusion of litigation In any court. S~Mi~ART The AIOPA. believes that the ta~ laws should be made as cOnsistent as possible in similar provisions of related sections and in addition that they should not contain provisions which are adm1m'~tratively Impractical Differences among similar provisions, such aS See. 6166 and 308, presently cause confusIon and Inequities among taxpayCre, and we feel our recommendations would result In greater fairness. ~ * We believe that the recommendations contained In this section will bring about better results admnist~atively' and will be ~~re acceptable to taxpayers in various situations, PAGENO="0348" 334 c'oncius~on The AICPA believes that the recommendations In this ~eport provide a scoind basis for federal estate and klft ta~ reform as far as the five areas reviewed Care eone~rned, The AICPA feels that it has confprmed the principles of fairness and simplicity to the extent that these two principles can be combined in this .cemiection. The CHAIRMAN. Next, we will hear from the Chamber of Commerce of the United States of America. They have been before us many times. Mr. Walker Winter. STATEMENT OF WAL~E~ W1NTE~ Mr. Wi~n.. Thank you, Mr. Chairman. My name is Walker Winter. I am a member of the board of directors of the chamber of Commerce of the United States, and chairman of its taxation coin~nittee. I am also a partner in the Chicago law firm of Ross, Hardies, Q'Iceefe, Babcock & Parsons, I an~ accompanied by Donald McDonald, a partner in the Philadel- phia law firm of Montgomery, McCracken. Walker & Rhoads, and Robert R, Statham director of the tax and finance section of the chamber. Mr Chturinan, the national chamber appreciates this opportunity to present its views on the general subject of Federal estate and gift taxes. I will summarize our statement, but ask that it be ]placed in the record as though read in full. I might say there is much that the American Bafikers Association and the AICPA have said that we can associate ourselves with. Our recommendatiojis that we will outline will be a little more `brief and a little more simple, I believe. It is time to reexamine Federal estate and gift taxes in terms of equity, inflation, and the adverse effects on family~owned and small Closely held busine~ses. These tax laws and their high rates have been virtually unchanged since 1942. While the cost of living has more than doubled. Excessively high estate tax rates disrupt the family's economic position and produce harmful effects on the private enterprise system. In the case of estates of owners of small family-owned, businesses, the tax problem can be particularly acute. Few estates of this kind include large amounts of liquid assets with which to pay taxes, Typically, such an estate is primarily composed of closely held assets of the business, making it necessary on the death of the principal share- holders to sell a. substantial portion of his holdings to pay the death tax. Often, inorder to meet the tax lithility, stock must be sold in such amounts that the decedent's family could lose control of the business. At times, complete liquidation of the enterprise may be necessary. The consequences of the estate and gift tax can be a heavy burden on those small enterprises which have a vital role in the country's economy. The present $60,000 exemption was enacted in 1~42, and it has not been changed since then. The effect of inflation on the fixed dollar amount of the $60,000 exemption is a substantial increase in estate taxes. Because of the inflated values of land and business assets, the exemption no longer pro~ides a circuit breaker against the forced sale of closely held businesses and family-owned farms. PAGENO="0349" 335 ~ The plain fact is that the $60,000 exemption is just not wo~Ii what, it w as in 1942 Inflation has su~bstantia1Iy reduced the intended effect of the exemption. The intent of the original exemption was to allow a reasonable amount of the estate to be untaxed to insure that a surviving spouse and children could support themselves. A sufficient amount of capital should be exempted from tax to provide an annual income for the de- cedent's dependents. Even this test does not give full consideration to the economic status to which the family has been accustomed. We would urge an increase in the $60,000 to $200,000 for the estate tax exemption. Turning now to the gift tax, we support an increase in the Federal gift tax annual exclusion to $6,000. The current $3,000 amount has been in the law since 1942. The exclusion is intended to allow small gifts without the adminis- trative burden ocf 111mg gift taz returns The gift tax exclusion repre- sents a means by which, without additional tax burden, one can provide for persons to whom the donor owes a moral duty to support and maintain. The current amount is too small and certainly not worth what it was over three decades ago. We support an increase in the Federal gift tax lifetime specific ex emption to $60,000 The current $30,000 exemption has been in effect since 1943. If the exemption were increased to $60,000, owners of small closely held businesses and family-owned farms would be encouraged to transfer a part interest in the enterprise while still alive. This would help to encourage the retention of such operations within the family and still allow for the expertise of older and more experienced per- soimel to aid in its successful operation We favor a reduction in interest rates on i~nstallment payments for estates of closely held businesses This came into law by the enactment of sectmn 6166 I happened to be ~i member of the joint committee staff at the time, and it was consi4ered most important by the Ways and Means Committee to avoid forced mergers of small closely held businesses. This reduction should result in a differential of 2 percentage points between the interest paid on 10 year installments of estate taxes and the interest paid on other deterred taxes Estates of closely held businesses have experienced difficulty with the 10 year installment pro visions under the Internal Revenue Code because of the increased in- terest rates under Public Law 9~-625 The 1915 change in the law sub- stantially reduced the intended effect of the deferral of estate tax pay- ments for family~owned farms and closely-held businesses. Amendment should be made to the current law to require a 2 percent reduction on the interest rates of these deferred estate tax payments as compared to the interest paid on other deferred taxes In other words, a 2 percent interest differential This was the law prior to the amend- ment under Public Law 93-625. In reviewing the Federal estate and gift tax laws, serious attention should be given tothe adverse economic and social consequences of `the present highly progressive rates The high rates impair the incentive to continue the family business for the future generations of the family. PAGENO="0350" 336 The estate and gift tax laws should avoid the demoralizing impact of these taxes on individual incentive, especially considering the rela- tively small amount of recenue derived.. We support the current stepped-up basis rules for assets acquired from a decedent. We oppose the imposition of a tax at capital gains rates on the net gains accrued on capital assets at the time of transfer by death. We are equally opposed because of its comple~dty, to a method. of carrying over the decedent's basis for property so acquired. * A tax on the appreciation of property passing at death would be a departure from the income tax concept of capital gains. There is no sale or exchange or voluntary conversion of property that is left by a decedent. Consequently, any such tax would constitute a. new and additional capital levy on death. In effect, it would be an ad- ditional estate tax imposed specifically on those who have taken in- vestment risks. ,. With.regard to closely-held businesses, this type of tax would prob- ably result in a gain determined by a highly speculative fair market value over cost-whether or not there is ~ market for the property or whether fair ma~rket value could be realized on the sale of the property. It could amount to a tax on the invested wOrk of the owners. The effect could be to force many closely-held. busi~iesses to sell out to, or merge into, larger corporations whose mar1~etable securities would provide the needed liquidity to pay heavy death taxes. We cannot overemphasize our opposition to any change in the COde which would tax appr~ciation f property at death; or provide for a, carrypverof basis. Thesechanges could add considerable expense to the administration of estates~ * * *, * ~&ny,such proposals `would, cause additional liquidity problems, im- pose unwarranted hardships on the dopéndénts and beneficiaries of those who have s~pp.iled much of. the inve~tinent capital necessary for this èountry's ec~onomic growth, and add uncertainty, inequity, and ~~iple~ity to the tax system. .,. *. * j[ We believe there shóiildbe no~ imposition of an additional tax on Itransfers merely because they result, or might result, in property not ~being subjected to a transfer tax for one br ~rioi~ generations. A tax. ~ c~n transfers which skip a ,gonej~ation would~pi~obably encourage out- ~ ~,ight giftsand disc~ouragë théu~~ of truets. There is no i~easOn why gifts,in trust should be subjected to a higher tax than outright gifts. Such a.ta~ would .tOnd to concentrate wealth in. the hands of children, whereas it ,friight be more desirabh~ to preserv& some of that prop~rty for a future generation. In addition, the over- whelming majority of trnsts are created to provideiixcome for the bene- ficiaries and to conserve the tra;nsferred property, rather than to ~avoid tax. We support the present marital deduction of one-half of the adjusted gross estate for estate tax purposes, and one-half of the amount trans- ferred in the case of gifts. Under present law, in order to qualify for the marital deduction for transfers at death, the pi'operty must be trans- ferred directly from the decedent to the surviving spouse, the value ~f the property must be included in the decedent's gross estate, and the surviving spouse must be given out~ight ownership, or it~ equiva- lent, of the property. . With regard to the problem of equality between residents of comrn- PAGENO="0351" 337 munity property States and conimon law States, present law .aileviate~ this problem, even though the taxe&in common law States are still not equal in all respects to those in community p~'operty States~ An un~ limited marital deduction would be basically unfair to unmarried persons or those who do not leave property to their spouses. The present separate estate and gift taxes should not be combined. into a unified transfer tax. If the total tax will be the sanie whether or not the property is given away during life pr ~t death, donors will be more inclined to hold property until their death, thereby being the victims of a new lock-in effect of such a unified tax. The encourage- ment to make lifetime gifts to avoid the lock-in effect, which is the situation under present law, would be removed. Thus, the eircourage- ment to dispose of property by gj~t during life would be stifled. Family. c~roumstances rather than the tax laws should determine when property transfers are advisable. The making of lifetime gifts that, can* permit younger individuals to make investments and entei~ business ventures should not be discouraged by the ta~ laws. I would like to conclude my remarks by commending the commit- tee on making available the very fine committee print on background materials on Federal estate and. gift tax laws. This document of ma- terials provides !a large source o~ information and is of great value. We thank you for this valuable document. And thank you again for hearing us. The CIJAnlMA~. Thank yort, Mr. Winter.. Without objection, the full statemeirt will appear ìü the record, [The prepared statement follows:] SrATEMENPOr mE CnAMBEB'O~' COMMEnOIrOF run UNIPED STkPES B~ WALKER Wncrrrn My name is Walker Winter. .1 am `a xr~ernber of the Beard of.i~irectors of the Chamber ~ `Qqmmerce of the Uuited `States and Chairman of its Taxation Coin- xnittee. I. am also apartnqr n~t~e Oh~cago law lirm of Boss, Rardles. O'Kw~f~ Babcock and Parso~. I ai~i aceoi~panie~I ky Robert ~, 5tatharn, D1~eçtor of the Tax and Finance Section of the Chamber. , Mr, C~4rman, the National Chamber appreciates this opportpnity t~ present; Its views on the general subject `of federal estate and gift taxes~ ,~umni~rv,of chamber's po~i~t~ It~s time to reexamine'federal estate and gift taxes in terms of equity, in~atiori,' and t1i~ a4verse. effects on Ily owned t~nd s~uall closeIL~ie14 businesses. These tax laws and their high rates have been ylrtualjy unchauged `since 1942. The National Chamber urges a redaction In the estate and~ gift,.tax rates. We support an~ increase In the estate `tax exemption, `the,gift tax.iifetime exe~ptiol~, and the gift tax annual exclusion. We favor a reduction in the rate of interest when the 10-year Installment method of paying estate t~txes is used. `There should be no change in tbe'present s1~epped~up~basis iilles for assets acquired from a decedent, estate tax marital deduction, separate estate sand gift taxes, and the $5,000 employee's death benefit exclusion. There sileuld' be no additional tax Imposed on transfers of property which may not be subject to a transfer tax for' one or more generations.' The need for reform Excessively l4gh estate tax rates disrupt t1I~ family's economic position and prOduce harmful e'ects on the private enterprise systew,~ So far as the estate tax is concerned, muclf of tile discussion would be incopsequential were `it nqt for' high rates wlil4h rise rapidly to 30 percent for a taxable estate of $100,000. When estate tax rates become unreasQnable, eyery dollar, of property included iri~ the gross estate becomes important, Minor defects in the law are magnified aud~ injustices become real problems requiring legislative soliltion. PAGENO="0352" 338 The tax law should be just as eon~erned with the future tax base as with present revenues. Private ~apita1 is the basis ~ the Atnerlcrn ~economic system, and a ready supply of such ~apitai is essentk~i to the ~tabiUty and continued economic growth of the United States. According to the 1975 Fortuiie survey of industry medians of assets per employee, about $50;000 of capital is required on the average in a metal manufacturing business to employ one person. The federal estate and gift taxes are capital levies, and, as such, steadily reduce private capital avaiThie for investment. The re~u1t, hut for infition, can be a con- stant erosion of the tax base. If the estate tax deters the building of wealth through productive enterprise, there could came a time when eemparathely l4ttie wealth would be available for capital ventures, In the cases of estates of owners of small family owned businesses, the tax problem can be particularly acute. ~`ew estates of thi~ kind include large amounts of liquid assets with which to pay taxes. Typically, such an estate is primarily composed of closely held assets of the business, making it necessari~ on the death of the principal shareholder to sell a substantial portion of his holdings to pay the death tax. Often, in order to meet the tax liability, stack must be sold in such amounts that the decendent's family could lose contro' of the business. At times, complete liquidation of the enterprise may be necessary. The consequences of the estate and gift tax ~an be a heavy burden on those small enterprises which have a vital role in the country's economy. Estate taa ewensption We support an Increase In the federal estate tax exemption from $60,000 to $200,000. The 1916 Revenue Act, which enacted the estate tax, allowed a $50,000 exemption Because of the excessive rates the exemption was raised to $100 000 under the 1926 Bevenne Act. In response to needed revennes during the Great Depression, the exemption was reduced from $1~,000 to $50~000 under the 193~ Revenue Act. In a further response to revenue needs, the $50,000 exemption was reduced to $40 000 under the 1935 It'evenpe Act remaining there until 1942 During the period from 1918 to 1b42 there also was a special exemption of $40,000 for life Insuranne payable to specific beneficiaries. In 1942, `the epeelal Insurance exemption was eliminated and `the present $60,000 exemption was enacted. It has not been changed in the past 34 years. The effect of~mftatlon on the fixed dollar amount ef The $60~0G)0 exemptilOn Is a substantial increase In estate taxes. Because of the Inflated values of land and business assets, the exemption no lor~ger provides a circuit breaker against the forced sale of closely-held bu,stnesses' family-owned farms. ~The plain fact Is that the $U0,00'exeinptiofl Is itist not worth what it was in 1942. Inflation has aobstantiaily reduced the tatended effect `Of the `eleinption*. To maintain an egurvalent amount of purchasing power in 1~Th dollars based on the Consumer Price Thdex, the original $60A)® estate faa exern'ptina should be about $198,000 for 1975. The Intent of the original exemption wan to allow a reason~hle amOofl~ `of the estate to be untaxed to lnsurO that a surviring spouse and nhiltlreri CoOld support themselves. When adopted in 1942, the present exemption wou'd have provided .suffieient capital to produce enough income to support the decedent's dependents. This is no longer true. Today In common stocks, It would pr~vtde only $2,100 to $~,400 of `pretax annital income. A su~'cient amount of capital should be exempted from tax to provide an annual income for the decedent's dependents Fven this test does not give full consideration to the economic status to which the f~miiy has been accustomed. Gift taco annual ecreiusion We support an increase In the federal gift tax Thnufl exclusion to $6,000~' Under current law, the first $3,000 of gifts made to `any one person during a calendar year is excluded for pu~oses of computing the tax. Gifts to third par~ ties by a husband or wife may be treated as having been made one~half from each with `the result that each spouse may claim an annual exclusion. The first federal gift tax was imposed in 1924 but repealed in 1926. The present gift tax law dates from the 1932 Revenue Act, which included an annual gift tax exclusion of $5,000 for gifts to any person. The 1938 Revenue Act re- duced the annual exclusion to $4000 The 1942 Revenue Act reduced the annual exclusion to $3,000, where it has remained. The exclusion Is intended to allow small gifts without the sdmirnstrative burden of filing gift tax returns. It must be remembered that the gift tax ex- ~luMon represents a means by which, wlthout additional tax `burden, one can provide for persons to whom the donor owes a mor~i duty to support and main- PAGENO="0353" 339 tam. Aged and indigent relatives, widowed daughters-in-law, disabled veterans, and the eduCation of grandchildren: tome within the gift t~x exclusion. In many cases It does not cover a year's tuition. The current amount is too small and certainly not worth what it was orer three decades ago. We support an increase ifi the gift tax annual exclusion to $6,000. Gift taa~ lifetime speeifk' ea~emption We snpport an. ihcrehse in the federal gift tax lifetime specific exemption to $80,000. Under present law, a lifetime specific exemption of $30,000 is allowed to each United States citizen or tesident, This gift tax specific exemption is not an annual exemption but may be spread over the donor's lifetime at his choice. No part of the $80,000 specific exemption may be attributable to the other spouse, and once exhausted, there is no further specific exemption available. The specific exemption was $50,000 for the period 1982 to 1935 and $40,000 for the period 1936 to 1942. The current $30,000 exemption has been in effect since 1943. We support an increase in the specific exemption for the same general reasons that the gift tax annual exclusion should be ificreased. The 1932 Act provided for the gift tax lifetime speciti~ exemption to correspond to the speCific exemption irithe estate tax law1 If the exemption were increased to $60,000, owners of small closely-held businesses ~nd family-owned farms would be encouraged to transfer a part interest in the enterprise while still alive. This' would Iieip to encourage the retention of such operãtiens within the family and still allow for the exper- tise of older and more experienced personnel to aid in Its successful operation. Inslailment payments jor e8tates of elOsel~ hel~t businesses We favor a reduction in interest rates on installment payments for estates of closely held businesses. This reduction should result in a differential of two per~ centage points between the interest paid ozi 10-year Installments Of estate taxeS and the interest paid on other `deferred taxes. Estates of closely~beld businesses have experienced difficulty With the 10~year Installment provisions under the Internal Revenue (lode because of ~tbe Increased interest `rates under Public Law 93-625. ` ` ` - Section 6161(a) (2) gives the Internal Revenue Service the authority to extend the time for payment of estate taxes for a reasonable periOd m~t ln~ excess of 10 years from the due date `of the return, If payment of the eState tax would crOate an "undue hardship to the estate." Undue hardship to the estate mO$ result where the personal representatWe could be forced to sell an interestin the family business to raise enough money topay the estate t~tx. SectIon 6166 of the Internal R~~enuC Code allows t~1e estate tax to be pale in installments over as in~ny aS 10 yearn where the estate consists largely of an interest In a closely~bel4 business or `family farm. Thi~ provision appites only if the v~atue of the- decsudent's terest in a closely beid bpsiness exceeds either 85 percent of his gross estate' `or ~0-~rØen-t çf his taxa~iie ehtflte. Only that pottion of the tax attributable -to the vaitte of~the litterest in the closely held business included in the estate Is eligible for the installment p~ments. Prior to Fuly 1, 1975, the interest rate on estate tax Instaflments was four per- cent per year. As a result of Public Law 98-625, sIgned Into law in 1975, the interest rate Is to be adjusted to approrimately 90 percent `of the commercial bank prime rate. The rate was initially set at nine percent but was adjusted to seven percent effective February 1, 1970. Before the recent change In the law, the interest charged on estate tax installment payments was two percent less than the interest charged on other deferred tax payments, The 1975 change In the law' substantially reduced the intended effect of the deferral of estate' tax payments for family-owned farms and closely held businesses. The House Ways and Means Committee Report On the Small Business Tax Revision Act of 1958 stated that the installment payments provision was pri- marily designed to keep together a~ business enterprise where the death of an owner of the business results in the imposition o~ a heavy estate tax. The report stated: "This provision is primarily designed to make It possible to keep together a business enterprise where the death of one of the larger `owners of the business results in the imposition of a relatively heavy estate tait. Where the decedent had a substantial proportion of his `estate invested in the business enterprise, under existing law this may confront the heirs with tl~e necessity of either break- ing up the business or of selling it to some larger business enterprise, in order to obtain funds to pay the Federal estate tax. tour committee believes that this result h~s an especially unfortunate result In the case of small businesses, 68-872---76--23 PAGENO="0354" 340 which traditionally also are closely held businesses. Therefore, although not removing any Federal estate tax in these cases, your committee hopes that by spreading out the period over which the estate tax may be paid, it will be possi- .ble for the estate, tax In most cases to be paid for out of earnings of the business, or at least that it will provide the heirs with time to obtain funds to pay the Federal estate tax without upsetting the operation of the business. Your commit- tee believes that this provision is particularly in~iportant In preventing corporate mergers and In maintaining the free enterprise system." [H.R. Rept. No. 2198, 85th Cong., 2d Se~s., p. 6.] The National Chamber urges an amendment to the current law to require a two percent reduction on the lntere~t rates of these deferred estate tax payments as compared to the interest paid on other deferred taxes. This was the law prior to the amendment under Public Law P3-625. Estate and gift tao rates `We support a reduction in estate and gift tax rates. The estate tax was adopted in its present form in 1916 in response to the government's quest for additional revenues. The quarter century between 116 and 1941 marked a substantial climb in estate tax rates. The 1916 `rates ranged from one percent on the first $50,000 of taxable assets to 10 percent on the amount over $5 million. The current rates, which have not been changed sInce 1942, rise raptaly from three percent of the first $5,000' of net estates to 30 percent at $1~0,000 and then more slowly to 77 percent on that amount over $10 million. The gift tax rates are three- fourths of the estate tax rates. In reviewing the federal estate and gift tax laws, serious attention should be given to the adverse economic and social consequences of the present highly progressive rates. The high r~ites Impair the Incentive to continue the family business for the future `generations of the family. Successful family enterprises are broken up and family ownership and control of enterprises destroyed as a result of estate and gift taxes. The estate and gift tax laws should avoid the demoralizing impact of these taxes on lndivldtiai incentive, especIally considering the relatively small amount of revenue derived. dapitai'gains tao at deat1i~ ` We support the current stepped-up basis rples for assets acquired from a de- cedent. We oppose the imposition of a tax at capital gaines rates on the net gains, accrued on capital assets at the time of' transfer by death. We are eauallv opposed carrying over the decedent's basis for property so acquired. Under the provisions of the Internal Revenue Code, the basis of property in the hands of a person acquiring it from a decedent is generally the fair market value of the property on the date of the decedent's death `or an alternative valua- tion date. The concept of a stepped-up basis at death has been In the tax law since the enactment of the estate tax In 1916. There have been proposals before to alter the present Code provisions on this subject by either taxing the apprecia- tion in value of property held until death, or requiring a carryover to the heir of the decedent's basis in the property. A tax on the appreciation of property passing atdeath would be a departure from the income tax concept of capital gains. An Income tax on capital gains arises on the voluntary conversion of property, by a sale or exchange, into another form in a closed tax transaction so that gain is actually realized. There is no sale or exchange or voluntary conversion of property that Is left by a decedent. Consequently, any such tax would constitute a new and additional capital levy on death. In effect, it would be an additional estate tax imposed specifically on those who have taken Investment risks, With regard to closely-held businesses, this type of tax would probably result In a gain determined by a highly speculative fair market value over cost- whether or not there is a market for the property or whether fair market value could be realized on the sale of the property. It could amount to a tsx on the invested work of the owners. The effect could be to force many closely-held businesses to sell out to, or merge into, larger corporations whose marketable securities would provide the needed liquidity to pay heavy death taxes. In some cases where property cannot be `divided for partial sale, a tax would be due, but funds to pay the tax would not be available. In other cases, where the asset fluctuates In value, even with the sale of the asset, because the tax is based on the "paper value" of the asset, there could be insufficient funds to pay the tax. With a very low basis and a high fair market value of the asset, the `Imposition of an estate tax as well as an additional capital gains tax, could pro- PAGENO="0355" 341 duce extreme hardship where stock is not readily marketable, 8~ In the ease ~xf a closely-held eorDor~tion, or Where the assetis uQt readily divi~ab1e. In this case, tax iiab~lity could exist without any considevatiob fQr the taxpayer's pra~tieal ability to pay the tax. A carryover basis is complex afld unworkable from. a recordkeepiug standpoint. In past years, taxpayers, in reliance on present law which does not rnquiro~proof of the decedent's bAsis in property held at death, have ~iot save ~cords. There are many instances where it would be impossible to determine the døcedent's cost or other basis in the property. Any such determination i~ould irnpo~e on exe~cutor~ and administrators the extremely. dlijleult, if not impossible, task of determining the decedent's cost of property which may have been held fot many yearser trans- ferred by gift over several generations. In addition; the problem of trying to establish fair market values of properties, even as of the date a new tax reformbjll becomes law, could be fantastic. It would parallel the problem In the law for decades of ~eterm'ining the value of property as of March 1, 1913. It is difficult enough now to determine the fair market value at the time a person dies, A tax on the appreciated value of property held at death ~could greatly add to the complexity of the federal tax laws. What would be the result with jointly owned property that is partially owue~ by the decedent and surviving spouSe, but with the spouse receiving part of the~property under th~ marital deduction? This problem results from the assignn~ent of a fair market value basis of part of the property at death and a proposed carryover basis in part of the property by the surviving spouse. Proponents of a capital gains tax at death overlook the taxes at both the fed- eral and state levels paid at death. The alleged "loophole" is that there is anun- realized appreciation of assets which arises from the 4ncrease in value over coSt, often the result of in11at1on~ without the payment of any income tax on this increase In value. However, these proponents fail `to recognize that there is a federal estate tax and a state estate or inheritance tax paid on the entire, vaiu~ including Increase in value. An argument is made that the current system favors holding assets until~ 4~atb, without paying a tax on the appreciated value, over selling before death and pay- ing a capital gains tax. This argumept overlooks the fact that this Is not an area of absolutes, .A sale ,o~ the asset before death, even with a taxand a resulting reduction in capital, ~an bav~ a number of bene~cialeconomic nbjeetlves. The si'k' of the asset prier to death assures its present gain, produces dIversity, for other investments, increases liquidity, and reduces the risk in holding the asset. The holder of assets untildeath does not `obtain these ecouomie~objectives and there~ fore shoi~1d not be forceçtto p~y an additional tax for the greater ri~ of. holding the ~s~et for a longer period of~time. Tbere'ls no assurance that t1i~ Imposition of a capitaj, gains tax at death would eliminate the so-called "lock-in" effe~t attributed to the hol4lng of property uutll death to avoid a capital gains tax that would result fr~m ~sale during lifetime. Even with such an additional tax, many decedeuts wpul4 still prefer to hold the property until death with the estate or their decendents paying ~the taxes owed. We ` cannot overemphasize our opposition to any change in the Co4e which would tax appreciation of property at death or provide for a carryover of basis. These changes could add considerable expense to the administration of estates. Any such proposals would cause additiOnal liquidity' problems, Impose nnwbr- ranted hardships on the dependents aml beneficiaries of those Who have supplied much of the investment capital necessary for this country's economic growth, and add uncertainty, inequIty and complexity to the tax systent Tr ` ving 9eneration skippin ` We believe there s u e no Imposition of an additional tax on tran~fers merely because they result, or might result, in property not being subjected to a tranfer tax for one or more generations. A tax on transfers which skip a generation would probably encourage out- right gifts and discourage the use of trusts. As an example, where certain family members have business acumen and others do not, it Would be advisable to leave certain property outright to those who could manage It. `L~o those who do not have the know-how to manage a bhsI~ess, it would be ~tdvisthleto leave prQperty' in trust for t~m to conserve their Interest In the property and provide income from it, as well, as to presery~ the p~oporty.itsejf. A~tax on transfers that do not violate the ~~le against perpetnittes, but that do in f~~t skipa gener~tien~ suth as gifts t~ grandcb~1dren, could ~anse iinpi~udent gift sltugtlotiS and discourage the use of trusts where trusts Shotild be.i*sed. ` PAGENO="0356" ~42 ~i'hete Is no reason why gifts in trust should be subjected to a higher tax than Outright gifts. Such a tax would tend to concentrate wealth in the hands of chil- dren, whereas it might be more desli~able to preserve same of that property for a future generation. In addition, the overwhelming majority of trusts are created to provide income for the beneficiaries and to conserve the transferred property, rather~than to avoidtax. Congress has never expressed an Intention to tax all property at least once in every generation or at periodic Intervals. As part of the Powers of Appointment Act o~ ~ Oongress enacted the forerunners of sections 2041 (a) (3) and 2514(d) of the 1954 Code. These sections of the estate and gift tax ia~t provide that if, through the exercise of a power of appointment, the holder of that power can create a truSt which will extend for a greater period of time than that per- muted by the common law rule against perpetuities, the property affected by the exercise Of that power shall he included within the taxable e~tate or the taxable gift of the perSon exercising that power. It ~ras at that time that eongress had before it the question of how long prop- erty should be permitted to remain in a private trust without generating a second eState tax. Its respotihe waS that the property would b~ allowed to remain in trust for the period permitted by the rule against perpetuities and that If It went beyond that time, a second estate tax should he applicable. There is no more reason now than there was in 1951 to provide for an additional estate tax unless the rule against perpetuities is violated. MaritaZ deduction We support the present marital deduction of one-half of the adjusted gross estate for estate tax purposes and one-half of the amount transferred In the case of gifts. Under present law, in order to qualify for the marital deduction for transfers at death, the property must be transferred directly from the decedent to the surviving spouse, the value of the property must he Included in the decedent's gross estate~ and the surviving spouse must be `iven outright owner- ship, or its equivalent, of the property. Proposals have been made to remove the present percentage limitations on the estate rand gift tax deductionS and allow gift-splitting between spouses to apply ta both lifetime and deathtime transfers on any desired basis. In the Treasury Department proposais in 1968 on this subject, estimates were made that the current loSs occasioned by an unlimited marital dethiction would be approxi- mately 18 percent of estate and gift tax revenues-declining to about 10 percent after 10 years. With reg~rd to the problem of equality between residents of community property states and common law states, presOnt law alleviates this problem, even though the taxes In common law states are still not equal in all respects to those In community property states. An unlimited tharital deduction would be basically unfair to unmarried persons or those who do not leave property to- their spouses. I~ there are revenueq available that could be used for an unlimited marital deduc- tion, whatever revenue loSs that would have resulted from an unlimited marital ~èdnctlon could better be spread across-the-board in the form of lower rates and- increased estate and gift tax exempt1on~. ~eparate estate and gift ta~ve8 The present separate estate and gift taxes should not be combined into *a named transfer tax4 Under current law, property transferred at death is subject to a federal estate tax utilizing a progressive rate -structure increasing with the size of the estate. Lifetime transfers, which -are in most instances eliminated from a decedent's estate, are subject to -a federal gift tax at rates 75 percent of the federal estate tax with the same progression as the estate tax. The taxes are separate so that gifts are taxed from the bottom of that schedule upwards and estates are taxed from the bOttom of that schedule upwards. - We oppose unification of es-tate and gift taxes., Gifts are voluntary in nature as compared to involuntary transfers due to death. If -the total toy will h~ the same whether or not the property is given away during life or at death, donors will be more inclined to hold ~property until their death, thereby being the victims of a new "lock-in" effect of such -a unified tax. The encouragement to make life- time gifts to avoid the lock-in effect, which Is the situation under present law, wonlr he removed. Thus, the encouragement to dispose of property by gift du~in~ life would be stifled. Family circumstances rather than the tax laws should ~determine when property transfers are advisable. The making of lifetime gifts that can permit younger individuals to make investments and enter business ventures should not be discouraged by the tax laws. PAGENO="0357" Even und~er a unified estate and gift tax system, it will be necessary tO deter- mine when a transfer Is to be ~taxed. Where, the. transfer would tto~ be covered specificatly by statutory provisions, the samO di~pnte~ and lltig~tio~i would occur under a unified system as under the present dual systena, it is unreasonable to throw out the present body of law administrative inter~retat1ons that have developed under the estate tax statutes for 60 years and uu~ler the gift tax statutes for 44 years. The result would be long years of litigation to sett1~ the problems arising under the new system. In addition, a unified tax would IncreaSti the costs of administration of estates and the burden of executers and administrators, since they would have to deter~ mine not only transfers made at death hut also the lifetime transfers of the transferor. This could result in liability of fiduciaries if transfers are overlooked and not accounted for in the estate tax return. ~or these reasons, we oppose a combination of the present separate estate and gift taxes Into a unified transfer tax. $5,000 emplOyee's dettlv benefit ea'clusion We support the $5,000 employee's death benefit delusion. Section 101(b) of the Code provides that amOunts tip to $5,00G, rece1~~jl by the beneficiaries Or the estate of an employee, paid by or on behalf of the em~p1oyer by reason of the death of the employee, a~e excluded from gross income. We believe the present $5,000 per employee limit is adequate ~o avQid apy abuse~ that mIght result from an employee having t*o ot n~ore employers wltl~ each employer paying death bezieftts. This exclusion should continue to he a~ll~ able regardless of whether the employer has a con~e~tor obligation to pa~y~ the benefits. This provisionheips to remove any inequity~jh ta~ treatment of benefits between employers who use commercial instirance and employers who use dIreet~~ payment plans. Conclusion In copelusion, the National Chamber urges a reexamination pf the present estate and gift tax laws, and a reduction ~n the estate and gift tax rates. We support an increase in the estate tax éxOinpfon, the gift tax lifetime e~emption, and the gift tAx annual exclusion. We favor a reduction in the tate of interest when the 10-year Installment method of paying estate taxes Is used, ~Iowever, there should be no change In the present stepped-up basis rules for aasets acquired from a decedent, estate tax marital deduction, ~eparate estate. and gift taxes, and the $5,000 employee's death benefit exclusion. There should be no additIonal. tax imposed on transfers of property which may nOt be subject t~ a trpzasfe~ tax for one or more generatIons. The CHAIn~tAN. Our next witness this aftei'noon is Mr Albert A. Waish~ National Realty Committee. Mr. Walsh, wel~ome to the committee. STATEMENT OP AL~ERT A. WAX$~ Mr. WALSHI Thank you verymuch, Mr. Ch~drman With yourpermission I would like to askthat iñy~rittenstatenient be filed withthe record. The CHAIRMAN. Without objection it will appeáf' in full in .th~ record. Mr. WALSH. I would like to present a very bri~t oral statement at this time. I think, Mr. Chairman, for the purpose of these hearings we should keep in mind that since 19Th ti~e real estat~,industry has de- clined far more rapidly than the rest of the private sector and ~s lag- ging far behind in terms of any long-term recovery.. Certain proposals to reform the estate tax now being considered can have a vital impact ou real estate investment, and should be viewed against this background of declining activity and high unemployment. In particular. we wish to comment on the suggestions that death he treated as a taxable disposi~ tion with any resulting paper profit subjected to inCome taxation, or. that in the alternative, such property take a carryover basis in the hands of the recipient. PAGENO="0358" 344 To the extent that these proposals involve the taxation of unrealized appreciation in the value of real property they must also be viewed in the light of certain undisputed, but not widely appreciated, facts about the real estate industry. 1. The real estate industry is essentially a composite of small entre- preneurial enterprises. In 1973, there were over 300,000 contract con- struction firms; over one-half of these bad three or fewer employees, and only 11 percent of them had 20 or more employees. Of the mpie than 150,000 firms engaged in real esate services and financing, 75 per. cent had three'or fewer employees. Nevertheless, the real estate in- dustry employed over 3,500,000 individuals, residing in every State. 2. Real estate is capital-intensive. Many real estate investments re- quire more capital than is available to a single individual. This is especially true today, and more true than it was a few years ago. A large n~nber of properties, therefore, are owned by groups of in- vestors, o:ften members of a single family. 3. Real estate investments are often not readily marketable. This is particularly true of individual participations in properties owned by more than one individual.Unlike stock market investments, interests in real estate, particularly nonincome producing property such as unim- proved land, may be virtually unmarketable from time to time. As is the case with any highly cyclical business, current values for real estate investments tend to fluctuate drastically, for example, dispositions of land and apartment projects in certain parts of the country are cur- rently at a virtual standstill. Forced sales create distressed prices. Our written statement sets forth the concerns `of the real estate in- dustry, and of the National Realty Committee, with regard to the realization at death proposal, and its carryover `basis alternative, in considerable detail. In the limited time available for an oral presentation, we wish to emphasize only a few points: 1. With respect to real estate, the concept of constructive realiza- tion of income is wholly unrealistic and artificial The income tax should be imposed only on income, not wealth. The estate and gift taxes are intended to be imposed on the privilege of transferring wealth and do represent a form of capital levy. No justification exists for imposing an additional capital levy in the guise of a tax on nonex- isting income. 2. The income realization at death proposal is essentially punitive. Death is not a disreetionary disposition; nonrecognition of alleged gain for income tax purposes is an appropriate tax treatment in this situation. The proposal purports to impose a tax on gain arguably avoided by the decedent during his lifetime. However, in reality, the `tax is not imposed upon the decedent, but upon his transferees, who are already, appropriately, subject to the burdens of the estate tax on such trans- fers. Moreover, any income tax relating to gain supposedly realized but not recognized `by the decedent during his lifetime does not bear any clear relationship to the value of the decedent's property actually passing to his heirs, which is subject to estate `taxes. `~The proposal does not consider the effects of inflation. If a decedent is to be taxed on gains, such gains should be real dollar gains, and not merely illusotry. Moreover, only the net real dollar gains should be taxed under the theory of this proposal, `as no other gains have avoided PAGENO="0359" 345 taxation. Any other approach would simply pena1iz~ a t~xpaycr for the sharp decline in the purchasing power of the dollar after his acqui sition of an asset. 3. Realization at death does not constitute a workable solution to the so-called lock-in problem. The proponents of this suggestion assert that taxpayers currently hold appreciated property until death in order to avoid incurring a capital gain on the disposition of such property. They further assume that, `by creating a sale for tax purposes upon. death, this proposal will have the effect of forcing taxpayers to make lifetime taxable dispositions. In fact, few taxpayers tetain ownership of property in order to obtain a step up in basis for their heirs. Property is retained because the net proceeds to be derived from a taxable disposition of it will not be sufficient to acquire a comparable in%estment This has become in creasingly true as the ma~amum effective rate of tax on individual capital gains has been increased by the elimination of the alternative tax, the proposed modifications in the minimum tax, and the enactment of many State and even municipal capital gains taxes. I would like to note for the record at this point that in the city and State of New York, the aggregate capital gains taxation now exceeds 50 percent. Consequently the appropriate solution to the so-called lock- in effect would be a reformation of the existing structure of taxing lifetime capital gains, for example, a tax imposed at graduated rates, decreasing the longer an asset is held, on real dollar gains 4. The alleged revenue gain from such a proposal is also artificial and illusory. The revenue as~umptions implicit in the proposal pro- ceed from' the erroneous assumption that transfers on death are or should be taxable disposit~ons This is contrary to the basic premise underlying the income tax that no income is created for tax purposes by mere unrealized appreciation in the value of assets. Any departure from that basic premise would create a dangerous, and potentially' de- structive, precedent. Furthermore, the proliferation of forced sales resulting from the enactment of any such proposal would aggrevate the current trend away from the private ownership of real estate toward corporate and other institutional ownership, including pension funds and other tax- exempt entities.' This would not only bring about a further, and in my judgment undesirable, concentration of economic power in the corpo- rate sector but it would ultimately result in a net loss of both income tax and estate tax revenues. 5. The carryover basis proposal would create extraordinary admin- istrative problems, as a result of the practical difficulties involved in determining the decedent's adjusted basis for property which may have been acquired several decades ago and which may have been substan- tially affected by intervening events. 6. Sound tax policy mandates retention of the existing estate tax pattern. The existing pattern serves as a practical inflation adjustment by imposing an estate (transfer) tax based on market value as the price of a change in basis to such value in the hands of the decedent's trans feree Such an approach is logically consistent with the workings of the Federal gift tax While such an approach does not clearly facih tate capital formation, it at least has the limited virtue of admmistra tive convenience and of not actively destroying small businesses and entrepreneurial real estate enterprises through forced sales required to pay both estate and income taxes. PAGENO="0360" 346. 7. if anything, an appropriate change in the existin~ estate tax structure would be: (a) the addition of a more liberal met~'hod of pay- ment of estate taxes on appreciated holdings of capital not represented by cash or marketable securities, such as interests in closely held busi- nesses and real estate investments; (b) a change in the estate tax exemption and rates, to reflect the etTects of inflation. Thank you, Mr. Chairman, for this opportunity to testify before your committee. [The prepared statement follows:] STATEMENT or ALBEnT A. WALSH, NATIONAL flEALTY COMMITTEE Sunvm.ary In general The real estate industry is essentially a composite of small entrepreneurial enterprises. Most Investment real estate is owned by individuals, often by family groups. Real estate Is comparatively less marketable than securlttm. Particularly dur- ing periods of economic decline there, may be no available market for the expedi- tious liquidation of a real estate investment at a fair price. This relative lJli- quidity of real estate Investment tends, to act as a disincentive to private invest- ment which must be offset by increased rates of return compared to more market- able investments of comparable risk. CurrenUy the reaj estate industry finds it increasingly difficult to secure prIvate risk capital. Congress has recently considered enactment of various Incentives to capital formation. Most existing (and proposed) tax Incentives to capital formation are not available to `real estate. Enactment of `proposals to subject unrealized appreciation In value of property to capital gain taxation on the death of the owner or to provide for a carryover basis at death, in lieu of the current law provisions granting a new basis for Income tax purposes equal to the value of the property at the date of death, would serve further to discourage Influx of vitally-needed additional capital into real estate construction, and would disrupt existing patterns of capital formation. Rcaliraflon at death A "realization at death" provision would be punitive addition to existing estate taxes. It imposes the burden of a tax on the wrong party. In the guise of remedy- ing a loophole enjoyed by the decedent prior to his death, the proposal imposes a tax ~s hich is effectively borne by the decedent s heirs This tax has no neces sary relationship to the value of, the property transferred to such heirs, which value is already subject to estate taxes. Such a provision would treat death as a discretionaryact, and further intensify the effect of existing estate taxation insofar as it forces a sale of small businesses, privately held real estate, farms, etc. Since most real estate investments are not marketable with the ease of publicly-held and traded stocks and securities, forced sales will often result In substantial losses. Minority interests In real estate in- vestments are even less marketable and thus more apt to be sold at "distress sale" prices. In short, such a provision would seriously damage the ability of private-sector entrepreneurs to build up capital in any permanent fashion, would eliminate many small enterprises, and would act as a significant disincentive to further real estate investment. Carryover basis on death The alternative proposal to enact a "carryover" basis on death would create grave burdens for taxpayers required to prove a decedent's original basis for property, and all adjustments thereto over what may be a very long period of time, without the benefit of the decedent's testimony and in many cases with inadequate records. This problem would exist to ~ome extent nuder the realiza- tion at death proposal but would be exacerbated by a carryover basis proposal, since the heirs would in many cases be compelled to retain the Inherited real estate for further lengthy periods of time, in order to avoid the very heavy capital gains taxes which may be currently imposed upon essentially illusory inflationary gains of many jurisdictions. PAGENO="0361" 347 Con~cZu8iofl8 While existing law is far from perfect, It has the limited virtues: (a) of con~ ferring a type of "inl1~tion adjustment," since tlecec~ent's transferees obtain a step-up In basis a~fter payment of a tax `based on the' property~s market value; and (b) of facilit~'ting taxpayer compliance and tax administration. The present estate tax is itself burdeusome in many instances, but Is at least consistent with tJ~e Congressional purpose to tax tran~fers of property, whether or not appreciated, on death. Imposition of an Income tax at this ti~ue would, however, result in the ~orced sale of many small businesses and of family-held real estate, in order to obtain funds to pay the tax otu what might well, be an illusory gain caused by inflation. ~~tatemertt Mr. Chairman and members of the committee, my name is Albert A. Walsh. I am the President of the National Realty Committee (NRC), a non-profit business league whose membership inclUdes ~ners, operators and developers of all types of real estate throughout the United States, , , I believe that, for the purpose of these hearings, we must keep'1t~ mi,u4 the fact that the real estate industry has suffered more from the recent combination of recession and inflation than any. other sector of the economy and Is lagging far behind in terms of any long term recovery. such hopeful signs as exist are con- fined almost exclusively' to the construction u~f one family housing in suburban and rural areas with almost no activity in non~re5identlal development or multi- family housing, As you know, multi-family housing starts are down from t05 million in 1972,, to 445,000 in 1974 and 269,000 in 1975 and, for a variety of reasons which are well known to the members of this committee and even better known to the members of the Banking. Currency and Hotising Committee, there is almost no hope of a significant Increase in 1976. The same is true for SOme of the same reasons, for private non-re~identIa1 eOnstructlon~ As a result, we now have 873,000 unemployed construction workers In the United States; a 122 percent Increase Since 1972. In my o*n `home city of New York, where construction unemployment approaches 40 percent, more than 16,000 construction jobs were lost last year alone. `The situation Is the same In most cities north and east of the so-called "sun-belt." And for every construction job lost there are 1.1 jobs ~ost in aWed fields. Certain proposals to "reform" the estate tax now being considered can have a vital Impact on real est~e investment, and should be viewed against his back- ground of declining activity and high unemployment. They should also be viewed in terms of certain undisputed, but not widely understood, facts about the nature and character of the real estate industry. 1. The real esta~e industry is essentlaihi a con.i~posite of small entrepreneurial enterprises.-Tn 1~'t3, there were over 300,000 contract construction firms; over one-half, of these had three or fewer employees, and only 11% of them had 20 or more employees. Of the more than 150,000 firms engaged in real estate services and financing, 75% had three ~r fewer employees. Nevertheless, the real estate industry employed over 8500,000 IndivIduals, residing4n every state. 2. Re~Z estate is. capitaZ~in$n,~ive.-~--Many real estate investments ~eqnlre more capital than Is available to a single individual, A iarge number of properties, therefore, are owned by groups of investors, often members o~ a single family. 3. Real estate investments are often not read1l~ marketable.-This Is par- ticularly true of individual participations in properties owned by more than one individual. Unlike stock market investments, interests in real estate, particularly non-Income pro~uclng property such as unimpro~red land, may be virtually un- marketable froiti time to time, As is the case with any highly cyclical business, current values for real estate investments tend to fluctuate drastically; for ex- ample, dispositions ~of land and apartment projects In certain parts of the country are currently at a virtual standstill, Forced salee create distressed pri('es. The specific concern of the real estate Industry, and of the Notional Realty Committee, with the subject of estate and gift taxation is the widely publicized proposal that death he treated as a taxable disposition with any resulting paper "profit" subjected to income taxation, or that, In the alternative such property take a "carryover" basis In the hands of the recipient. In Its "Tax Reform Studies `and Proposals'~ of 1989. (JoInt Puhilcatloft of the Committee on Ways and Means of the U.S. Rouse of Representatives and c~om- xnittee on Finance of the U.S. Senate, Committee PrInt, 91st Cotig., 1st Se~s., PAGENO="0362" 348 Feb. 5, 1969), the Treasury stated its arguments in favor of taxation of capital gains at death In Substance as follows: 1. This change would promote tax equity between the taxpayer who sold appreciated assets before death an~ incurred a lifetime capital gains tax and paid It, and the taxpayer who held appreciated assets until be died. 2. The existing law creates substantial revenue losses. 3. The existing law produces an Intense "lockin" effect, which this proposal would cure. With your permission, I would now like to comment In some detail on each of these argumenin and enumerate some of the other reasons why the National Realty Committee believes that no such change should be made In the existing pattern of estate taxation. I. Tilt CONCEPT OF "CONSThUCTIVE REALIZATION" OF INCOME AT DEATh IN NEITHER EQUITABLE NOR REALISTIC BUT IS WHOLLY ARTIFICIAL AND UNFAIR The example given by the Treasury of "Inequity" does not clearly demonstrate their point. The Treasury proposal contained the following comparison: "TAXPAYER INRQVITT "Assume Taxpayer A earns $200,000 and pays tax of 50 percent or $100,000. For simplicity, It is assumed that he intends to save half of his income and to consume half. This means that he will have $50,000 for consumption and $50,000 that he can Invest in, say common stock. Taxpayer B earns $100,000 on which we will say he pays 50 percent In tax and he uses this entirely for consumption. Taxpayer B, however, differs from A in that when the year started he already owned common stock worth $200,000; and during this period it rose In value by 50 percent or by $100,000. "Clearly Taxpayer A tried to increase his wealth by $100,000 He wanted to save half af his income, but the tax cut It down. He only Increased his wealth $50,000 after tax. B finds that his wealth has increased; and since our present tax law does not count unrealized appreciation In value as taxable Income, he Is able to add the whole Increase in value to his wealth. * * * * * * * "The estate tax will fall on both A and B so it is not relevant to say that B ought not to pay any Income tax on his accumulation of wealth "because he pays an estate tax." A has paid income tax on the money that he earned to build an estate and an estate tax. B avoided income tax on hIs wealth Increase and ony an estate tax was paid on it." It is insufficient justification for imposing a tax to be borne by B's heirs to allege that B who Is now deceased and beyond the taxing jurisdiction of even the United States Government, "avoided income tax on his wealth increase." The Income tax should be Imposed only on Income, not wealth. The estate and gift taxes are intended to be Imposed on the privilege of transferring wealth and do represent a form of capital levy. No justification exists for imposing an addi- tional capital levy in the guise of a tax on non-existing income. The example does not Indicate when or how Taxpayer B acquired common stock worth $200,000; If this was acquired by B by purchase, then B merely did In a prior year that which A was now doing, and it Is false to state the B "avoided" income tax. A will, after his Investment has been made, be able to "avoid" tax in the same manner as B. It is equally misleading to say that B will still be taxed more favorably if he holds his appreciation until death than If he sold It during lifetime. No taxpayer pays income tax prior to realization of income. Neither A nor B has to pay any income tax on any unrealized appreciation In the value of assets he owns. In addition, the longer B holds his property, the more likely it Is that his "apprecia- tion" will consist of gains due to currency devaluation. Wbll.e it is true that A, upon a current sale, pays a current tax, it is eaually true that A has disposable cash from the sale, which be can then spend at current values; the purchasing power of such dollars may exceed B's subsequent "paper" gains II. THE "INCOME REALIZATION ON DEATH" PROPOSAL IS ESSENTIALLT PUNITIVE Taxation of "paper gains" at death has the appearance of meaningful tav reform, but not the substance. This is in effect a punitive tax, Imposed on an Individual who either could not or would not dispose of a particular asset during his lifetime, and Is imposed in form on the decedent, as a tax on the PAGENO="0363" . 349 privilege of reta~n1ng th~ asset until death. However, the impact of the tax fails on the beneficiaries in the form of a diminution of the estt~te, and a forced sale of the asset ata disadvantageous price. ~ ~ Moreover, this may also be unfair to the deced~i1t, since It is questic~nab1e whether he ever benefited from this unrealized ` appreciation particulaily to the extent that it re~ttits from repeated declines in the purchasing power of money. ror e~ampie, a~sUrne that a man bong~it a hoth~ in 1946 for $10,000, livel In it for 30 years and, on his death In 1976, `the "market `value" o~ his home was $60 000 The $60,000 value will be subject to estate tax the burden of which will be borne by the beneficiary of the decedent ~ estate Imposing an additional income tax on a theoretical paper gain of $50 000, which never benefited the decedent, Is uncalled for. ` The progressive estate tax rate works together with inflation to produce automatic increases in the estate tax which is imposi~d on the value of assets transmitted at death These taxes automatically take into account the effect of Inflation on property owned by the decedent Under eaistlng law in return for paying a tax on the effects of ififiation, the decedent's transferee obtains a basis correspondingly increased. iii. TIlE "REVENUE LOSS" CITED BY THE TREASUISV IN 1960, AND BY OTHER PROPONENTS OF THIS "REFORM," IS ALSO ARTIFICIAL AND ILLUSORY The notion of a revenue loss proceeds from the erroneoua, but apparently unquestioned assumption that transfers at death are or should be taxable dis positions This is contrary to the basie premise under1~ing the income tax that no income is created for tax purposes by mere unrealjzed appreciation in the value of assets Any departure from that basic premiSe would create a dangerous and potentially destructive precedent~ Furthermore the proliferation of forced sales resulting from the enactment of any such proposal wo~uld aggravate the current trend away from the private ownership of real estate tøward corporate and other Institutional ownership Including foundations, pension funds and other tax exempt entitles. This would riot only bring about a further and in my judgment undesirable concentration of economic power in the corporate and tax exempt sector but It would ulti- niately result in a net loss of both income tax and estate tax revenues. IV. "REALIZATION AT DEATH" DOES NOT QONSTITUTE A WORKABLE SOLUTION TO TIlE SO-CALLED "LOCK-IN" P~OBLKM The proponents of this suggestion assert that taxpayers currently hold appre- elated property until death In order to "avoid' incurring a capital gain on the di~pos1tioh of such property They further assume that, by creating a sale' for tax purposes upon death this proposal will have the effect of forcing tax payers to make lifetime taxable dispositions. ` In fact taxation of capital gains on death would rot eliminate the existing "lock-in" effec~t before death, but would merely lead to forced sale~'of property `and small businesses at thedeath of a principal owner~ This Is because many taxpayers cannot afford to dispose of `appreciated' property during their life the capital gains tax is `io high that reinvestment of the net sales proceeds will not produce enough lifetime income. Note that there has been a significant increase In this rate since the Treasury Study was made from a maximum federal rate of 25% to a maximnur federal rate of 35% plus the minimum tax The total federal effective rate on capital gains can now ea'ceed 45% state and local taxes can bring this total to over 50% The alternative carryover basis proposal merely shifts: `the "lock-in" pSOblem from the decedent to the transferee who would In turn become "locked in' as a result of the gain inherent In the property. V. THE "CARRYOVER BASIS" PROPOSAL WOULD CREATE ExTRAoRDINARY ADMTNI5TRA'rIvE PROBLEMS The dimculty of maintaining. records of basis and basis adjustment through several generations Is formidable ~4ince the dece~tent's basis will be either cost (if the property were purchased by him) or his donor's basis (if he acquired the property by gift), this' basis may be virtually `Impossible to determine in the case of property acquired long ago. PAGENO="0364" 350 Many individuals have not maintained satisfactory records and substantial Litigation over the "basis" issue may be predicted if basis is "carried-over" in- definitely through successive transfers at death. $ueh disputes would be analogous to existing disputes with the Internal Revenue Service over the issue of the "value" of property at the time, of decedent's death, but would be infinitely more complex due to the presence of a multiplicity of issues concerning the evidentiary points Involved In. demonstrating the propriety and sufilciency o~ the evi4ence offered with respect to the "basis" point. See, e.g., Ja~m~$ E. UaWwelZ ~ Co. `v. Comnvi83ioner, 234 F.2c1 660, 49 AFTR 1485, 1956-2 UJfTC 19759 (6th, CircuIt, 1956), revers,~ng James ,E. Ca~dweU ~ Co., 24 TO 597. ~In sbort~' either lhe sale at death or the carryover basis provision would require a~ determination of the decedent's a,d~usted;'basis for the property at or * ~~hsequent to the time ~ his death. In consequence, the time required for an administration of many estates would be substantially Increased. Similarly, the cost of adminls~erlng an estate will substantially incrcase~ 1~ajrness requires that ally change in the law that makes basis pertinent, as each of these proposals does, permit a recipient of property from a decedent to use as the decedent's basis the property's value oi~ the effective date of the law change for purpoSes of computing gain, where such property was either owned by the decende~t on the date of enactment of the new statute, or was acquired by the decedent by gift from such a person. It mttst be noted that this would, of course, require valuation of all property in the United States, as of Such date (slmlla~ to the establishment of 1913 values); clearly this creates an enormous administrative' `task. Unless such values were binding on all tax- payers and on the Internal Revenue Service, this task would also be of only minimal value; It would simply bring forward In time the valuation date for purposes of disputes between taxpayers and the Service. If a decedent died 20 years after this date, the same problems of proof noted would exist. Current law has the v~jrtne of simplicity since the historical basis of the property becomes Irrelevant at death and problems of proof of original basis and all adjustments thereto disappear. While existing problems of, proof ` of value at the date of death are substantial, evidence with respect to this issue Is, In general, more r5aduiy obtainable since It Involves' curre~rt facts, rather than long-past history.' VI. SOUND mx POLICY MANDATES RETENTION OT THE EXISTING ESTATE TAX PATTERN The existing pattern serves as a practical "inflation adjustment" by imposing an estate (transfer) tax based on market value as the price of a change in basis to such value' tn'the hands of the decedent's tarnsferee. `While such an approach does not clearl~r facilitate capital formation, It `at least `has the limited virtue of `administrative convenience and of not actively destroying small businesses and entrepreneurial real estate enterprises through forced sales required to pay both estate and inconw taxes. An increase fri taxation `at death would not destroy existing Capital assets. but would clearly deplete the private sector's available capital. A substantial portion of the liquid ssetW~ realized by an estate' as a result of a forced sale of an appreciated asset wind up In the handS of the Preasury. Dollars used by the government are, by definition,' not available for private sector, capital formation, and do not' substantially' provide an indirect source of funds for this use. If, nevertheluss, the "realization at death" proposal is adopted, it is im- portant that your Committee sharply distinguish between an estate consisting of registered publicly-traded' and easily marketable securities and an estate consiSting of stock in a closely-held family enterprise or of closely-held appre- elated real property. l~'or most family firms, any paper appreciation in the value of this asset is not only unrealized, but unrealizable. Estates consisting of such an asset frequently are placed in a cash bind by existing estate tax law. Imposition of a further capital gains tax at death would simply increase the incidences of occurrence of this problem. Many such businesses need relief from `the effects of existing law, which frequently forces liquidation of the firm, due to its Inability to generate funds ~ufflcient' to pay the tax. If anything, the existing estate `tax structure, whether or not increased by k'provlsion providing for capital gains taxation at death, shopid be modified clearly to take Into consideration the effect of Inflation. ~or example, the existing estate tax should be Imposed at rates' whiCh bear the sam.e relation- ship to the current deflated value of the dollar as the 1942 estate tax rates bore to PAGENO="0365" 351 * the then ~much sounder currency. In addition, any pr~posal to tax capital gains at death should only tax "trite gains". The real solution to the "lock-in" problem, we submit, Is not imposition of tax at death, o~ a~1opt1on of a carryover ~asls at death, but the amendment of the income tax law to provide an incentive for lifetime sales, e.g., a graduated rate capital gains tax, Which results in a decrease In the rate of such tax the longer an asset is held, and/or an adjustment to basis to eliminate from tax illusory gains due solely to declines In the purchasing power of money. The OHAIRMAN. Thank you, Mr. Walsh, Finally on the panel, Mr. Robert Brandon, Public Citizen Tax Reform Research Group. Mr. Brandon, welcome to the committee. STATZMENT OF ROBERT M. BRANDON Mr. BRANDON. Thank you, Mr. Chairman. Withme today is William Pietz, a staff attorney with ourgroup. We appreciate the opportunity to be here and t~ talk about ~the reform of the estate and gift tax. * * To put the matter in perspective, I would like to say what we are really talking about is changes in the taxation o1~ the wealthiest 1Q percent Gf the decedents in the country. That happens to i~iclmie farmers and owners of sm~1i businesses. ** But I would suggest that, as was brought out this morning, farmers heirs who decide not to take farm estates that are left them and sell them~ but rather take the vowsof poverty, do.deserve~ a break from the estate tax. * * ** We have some specific proposals on how to deal with that very limited problem without a general liberalization of the estate tax~ and reduction in revenues. The estate tax itself origix~ally was a revenue raising measure. Specifically, ~n 1939, it brought in ~bout I percent of budget receipts. Today its share is down to about 1.5 percent. It * projected tobe around 1.3 percent in fiscal year 1981W * However, it still is a significant source of Federal revenue~ $4.6 billion in 1975 and about $7 billion by fiscal y~ar 1981. * * * * * * Assuming that we are stuck ~ith higher taxes,, it seems that `this committee has a to~ugh choice. Ph~ choice is Whether to shift an even greater burden on peoj~le'~ working ince1~tives through increased social security or income tax~s ~r to continue to taxer increase the taxes on the amounts which a4~1tscg~ inherit from ,their parents. Given those choices, it sem~s to me the committee should be looking for ways to broaden the estate and gift tax base. 4t a very minimum, any estate and gift tax `reform package should `be well balanced in order to avoid any reduction in tax revenues., I say this because the estate and gift tax really has some substantial advantages in bringing in Fed~ral revenues~ First, it tends to incthse the progressivity ~f' our general tax structure~-a basic prInci~le of taxation down through the years. According to t~e "1969 Tx~easury Studies," the estate and gift. tax alone accounted for about one..third of the progressivity'in our t~x system. * * It also tends to tax income that escapes~ through our income * ta~ system. It taxes those fortunate enough to figure * ways of getting around the present tax laws., And it generally evens out the race to acquiring possessions that all of us have to make atthe beginning ø~f our lives. , , * PAGENO="0366" 352 It is the least. distorting tax. It is levied on one's death and there- fore has less impact and ress interference with business and personal decisions during one's life. AM finally the impact of estate and gift taxes on those receiving the estate and gift bequest seems to be most fair. We are all trying to beat the cost of living, and if o~ne of us receives $60,000 by working during the year we are going to have, to pay a lo~ of tax on that. After that we are going to have to support our families, and pay, all of our `bills. A neighbor of ours may receive a bequest of the same $60,000 and not pay any tax at all under `the present system. `They will be able to feed their family and pay their bills with nontaxed dollars while the rest of us have to struggle with highly taxed dollars. It seems for `these reasons `that the estate and gift tax really is our "least bad" tax. In fact, with some exception which we will get to later, t~he present `tax is really not that burdensome. A very' small nmnber of wealthy estates actually are paying. Sixty perc~nt of estate and gift tax revenues come from the wealthiest two- tenths of 1 percent of all the decedants. The tax base is relatively small; 1978 `figures indicates that only 7 percent of all the decedants who d'ie each year wind up paying estate taxes. Today" we are probably talking about 10 percent of all the estates. We must keep in mind that any general liberalization of the estate tax is in fact a proposal to provide tax relief for the wealthiest 10 percent of all decedants. It seems to me if the committee discusses further reductions in Fed- eral revenue they should think about the 90 percent of our taxpayers whO struggle all through their lives to make ends meet and can't even IeaW'an estate that is taxed. These people are certai'nly more proper targets for tax relief. In terms of those people who actually pay the estate tax, the effective thtes are quite low. Look a't how progressive the tax really is. Million- aire's estates-1969 and 1973 figures showed that millionaire's estates pay roughly 21 percent of their net estate in estate taxes-including S~tate taxes. Estates of $10 million and above pay 17 percent. We have very specific areas of reform we would like to talk about. First, the present rate structux e we feel needs tightening From the point~of view of thb~e receiving income we have a situation where someone who is a solO beneficiary of a $1 million estate will pay a tax of about 27 percent. Those with smaller estates' will be paying begin- ning at about 3 percent. By contrast workers start at an' income tax rate of 14 percent plus payroll' taxes of 6 percent. The income tax rises to 50 percent when taxable income reaches $50,000. The estate tax rate does not reach 50 per~cen't until $2.5 million. Even if you `take into `account the income 5-year-averaging provi- sions in the income tax~ you have a situation where somebody, receiving $1 million of income `through a bequest, now pays a marginal rate of 38 pei~cent. `If that money was earned in 1 year through the income system-even if it was divided five ways-it would still yield $200,000 a year aM be taxed. at 70 percent under the current income tax system. Let's look at the estate tax exemption. The fact that the exemption has scarcely been looked at since 1942 hardly justifies incerases now. `The income tax in the last 60 years at almost every level has jumped at least tenfold. Since 1938 social security taxes have gone up from 1 PAGENO="0367" 353 percent to 5.85 percent. Since 1927, the Federal Government's expendi- tures have gone up from $25 per capita to far above $1,000. The simple truth is our other taxes were upgraded during and after l~~Torl~1 War II to parallel the growth of Government, while estate taxes have been completely ignored. rrIie present exemption, in- fact, protects 90 percent of all the docedants who die each year. If we increase it, we are simply helping those 10 percent fortunate enough to be able to leave estates. In fact increasing the exemption not only provides the relief for this narrow group, but the larger the estate, the greater the relief. We would suggest that you could still protect these 90 percent who now don't pay tax, and who we want to keep out of. the estate tax system by providing a credit-at a huge savings to the Federal Gov- ernment. A $950 credit would keep the same net taxable estate out of the estate tax and would pick up $750 million in revenue. Even a credit of $21,000 which would raise the. taxable estate threshold to an equivalent of what a $100,000 exemption would, would actually pick up $90 million. It seems to us that a credit, would be a much better proposal if we want to continue to grant relief to .the90 percent of estates that are now not taxable. Even if we want to go b.eyond that and add, say, another fi'~~e percent and onl.y tax the top 5 percent, we could do it by having a credit, in lieu- of exemption at a significant revenue savings. This morning there was a mention that the advantage of having a lower gift tax, that it promotes lifetime gifts. The present lifetime gifts are quite small, about 10 percent of the estate tax property. And in fact the gift tax system really helps only those, as I have said be- fore, who have the wherewithal to make those lifetime transfers. That minority's effective rates tend to be 55 or 60 percent of those who have to hang onto their assets until they die. We would support full integration of the estate and gift tax along the lines contained in Mr. Corman's H.R. 1040, and the 1969 Treasu~~-~ proposals. ~ must be taxed in terms to produce a tax eqiii~Tèncy roughly equal to other taxable transfers. The generation skipping trust is primarily available to estates of extremely large wealth. In 1957 to 1959, estates of $1 million or more transferred about 25 percent of their assets through generation skip- ping trusts but only 9 percent of assets in estates of less than $300,000 were transferred through generation skipping trusts. In extreme cases, estates can skip taxes for up to 100 years. Eliminat- ing generation skipping trusts could add as much as 10 percent to our estate tax revenues. We would also support taxing appreciation of capital assets at death. We feel the concern for the family asset problem should be dealt with specifically, and it should not obscure the fact that absence of capital gains at death is a major tax problem. One problem with any of the proposals to increase the exemption is the inordinate amount of revenue loss involved. We have a chart on page 6 of our statement which indicates some of the advantages of the tax credit in lieu of tax exemption in terms of the revenue impact. Next, we would support the integration of the present estate and gift tax system into one unified transfer tax. Presently, there is an PAGENO="0368" 354 enormous advantage to being able to split gifts over a lifetime and at death. That advantage accrues primarily to the very wealthy, and to those with the wherewithal `to have well-thought-out estate plans, and it catches all of the other unsuspecting people who don't give away their wealth during their life. In fact, the present exemption, considering we have a dual system is quite generous Given the annual gift exclusion of $3,000, up to $6,000 per couple-the lifetime gift exclusion of $30,000, up to $60,000 per couple-a couple can transfer $540,000 free of any transfer tax at all to three children over a 3-year period. That tax4ree wealth repre- sents the top 1 or 2 percent of the country. It seems to me we ought to integrate the two taxes. The present advantages accrue to the very wealthiest estates, someone who splits $1 million evenly between gift and bequest will save $78,000 in estate taxes, ~nd someone who splits 10 times that amount, $10 million, would get a savings of $1,768,000, more than 20 times as much. The Treasury has estimated that in some recent years 40 percent to 50 percent of estate values has been untaxed capital gain. By this analysis, $15 billion to $20 billion of gain went untaxed annually Failure to apply a capital gains tax at death cost about $4.5 billion in 1975, and will cost over $7 billion in fiscal year 1977 This largely accrues to the benefit of a very narrow gronp. Analysis of Treasury data for 1973 shows that 5 1 of taxpayers received 84 percent of all realized capital gains Probably a smaller unmber pass on unrealized gains at death. We also feel not taxing gains at deafh obviously, produces an. unde- sirable lock-in effect since ta~payers hold their assets until death in- stead of releasing the funds for possibly more productive uses which might pay a higher pretax market return. Those who can afford to hold their a~ssets are better off than less wealthy individuals who must periodically sell assets to raise cash or those who must build their estate through s~dary income. While some capital gains are attributable to inflation, some capital assets such a real etate have appreciated faster than the consumer price index which means thkt the owners' purchasing power has in- creased. Also, owners forced to pay a deferred tax on. capital gains w~uid still be in a better posititon than people, who pay taxes annu- ally on interest on fixed income debt securities. No adjustment is made in their tax bill for the inflation-induced loss of purchasing power represented in their interest returns, while wealthy ~investors will pay taxes at one-half the ordinary rates. MOreover, the purchase of many capital assets is financed by debt. Paying off such d~bt later in cheaper dollars produces an infiation-~nduced, profits which, of course, goes untaxed. Ignoring inflation in all other areas of the code in order to avoid intolerable complexity, while overcompensating for it in this area produces an unjustifiable distortion. Proposals to tax capital gains at death such as the 1969 Treasury proposal, contain an unlimited marital deduction, an orphan child exemption, a specific exemption of $60,000, exclusions for life insur- ance and household effects, 10~year averaging, provisions and exten- sion of time for making payments. These seem reasonable. The $60,000 would protect any good sized family resi4ence from the tax. In our concern for small family estates we should not lose sight of the fact that these estates are not really small. They are only small PAGENO="0369" 855 compared to very large estates. But compared' with `the 90 pei~ceiit of~TY.S. adnits w~ho leave n~t taxable e~tates at all, the recipients of thesebequests are very well off: Now, as a policy matter, Congress would not want to see families forced to sell the family home or business just to `pay the tax owed. But concern over illiquidity is a separate issue and should nOt obscure the fact that by far the largest iteem of appreciation in U.S. estates is marketable securities. If you look ftt table `II of my statethent we `have ~tatistics oü what assets make up capital gairffi at de~th. At least $14 billion of those $1S8 billion are asset~ such as marketable securities which irnrolve no liquidity problem. We `have some suggestions on the unlimited charitable deduction. It can be! argued that there is a good qase to be made as to why there can be an unlimited deduction for public charities. We feel, however, that transfers to private charities which tend to perpetuate private contrOl of wealth do not deserve the same generous treatm~nt. In fact, the income tax laws recognize this fact and' provide a lower deduc- tion from adjusted gross income for transfers to private foundations as Opposed to public charitIes~ `Consider the private charities. Treasury may be giving up, up to 77 cents on the dollar, but the jrivate founda- tion only has to `pay out ttt the rate of some 6 percent. We would actualy favo,r a credit shbstituted for the deduction of charitable contributions 1~o m~1èe the system hiore progressive, and to treat all gifts evenhandedly withoñt impairing gift-giving incentives. Let's turn to the marital deduction. As part of an overall estate and gift tax reform package, we would support a full, 100-percent marital deduction in recognition of the joint and unseverable contributions made by, spouses in buihuing an estate. This would alleviate the special problem faced by farm wives and is a logical exception to the pro~- posed income tax on capital gains at death, However, the cost of a full estate tax marital deduction might approximate 15 percent to 18 per- cent of the total estate tax rerenues in the short run and half of this in the long run as surviving spouses eventually die with larger estates. For that reasOn the committee might want to consider a ceil- ing on. `the marital deduction, A ceiling would `also minimize the es- tate tax relief that would be accorded those with great accumulated wealth who marry very youngspouses in their later years. Let's focus specifically, on family farms and businesses. We don't think the exemption should be increasCd for all taxpayers ~ust to assist small businesses or farms. As a matter of' perspe~ti've, for ex- ample, 1966. IRS data show~4 that, total returns filed showed grOss assets of $18.8 billion. TJntraded closed eOrporation stock totaled not more than $1.9 billion, noncorporate business assets totaled $~.5 billion, and "all real estate other than primary residence" totaled $27 billion, and by no means all of this was farm real estate. Section 6166 presently provides for 1Q-year installment payments `of estate taxes in `hardship cases. However, this provision i~ `almost never used because the executor who is empowered to request relief under this section is made personally liable for the 10-year install- ments. According to one IRS district oflicer in Omaha, only ~bout 5 percent of farm estates ever request relief under 616G~ and the TES 68-872-76----~-24' PAGENO="0370" 356 almost routinely grants the relief except for obvious cases of fraud. So in spite of all the discussion we are hearing about the farms hav- ing problems, they are not even getting access to this installment provision. Additionally, most commercial attorneys know much .of the estate tax burden for small businesses and farms can be alleviated by using life insurance proceeds which can be arranged to be outside the tax- able estate. Even with this help, however, many small farmers., and small businesses are treated unfairly by these estate taxes. And this isthe key. Their problem is one o1~ valuation. And that prob- lem should be dealt with as a problem of valuation and not generally in the estate tax. The small business problem basically is that there is no uniform standard for valuation. We have looked at some recently litig~ted cases in this area. Three things stand out, First, IRS almost always selects any valuation process that produces the highest figure. Second, tax- payers often fare poorly because of poor preparation and inadequate appraisals. Third, courts usually split the difference in a very unscien- tific way. But the anguish occasioned by these problems will not be solved by increasing the exemptiom-especially since the huge cost, a $150,000 exemption would cost an additional $1.7 billion, makes it likely that a very large increase will not be affordable. A small, closely held business is usually valued at ~i multiple of less than 10 times its annual after tax cash flow by would-be buyers. Assume the tax is from 8 percent to 77 percent of this value. By definition perimtting 10-year installment payments should enable the heir to pay off the tax from the business cash flow without selling the business We believe-as a number of legal practitioners have testified before this committee in prior years-that businesses are seldom sold for any reason other than the unwillingness or inability of heirs to carry on. But the committee may be justified in considering a limit on the multi- ple at which the IRS can capitalize earnings for estate valuation as well as technical adjustments in 6166 and 303 to assure their avail- ability to family businesses. We believe the farm problem is a more severe one because farms are land intensive. U.S. farm real estate values have been soaring. They increased 25 percent in 1973 and 14 percent in 1974. Clearly, the fair market value of land if sold to a developer exceeds its farm use value. According to USDA. surveys the average value of all farmland in the United States reached $370 per acre by March 1975, but land transfer- red to industrial uses brought $1,872 per acre. subdivision land `brought $1,574, and land converted to rural residential brought $974. In 1975 average farmland value per acre varied greatly geogi~aphically, for example, $2,500 in New Jersey, $600 in New York, $300, in `Kansas, $240 in Texas. Taxing this inflated paper value can create a problem, especially since farm estates are illiquid. Almost 80 percent of farm estate assets are in land `and machinery compared with an average of 20 percent for all U.S. estates. . But the problem should be kept in perspective. The transfer of land out of farming which exceeded a rate of 100,000 farms per year until the late 1960's has steadily declined and equalled only 26,000 farms in 1973, and a majority of these sales were probably made for reasons other than estate taxes. PAGENO="0371" 357 Nonetheless estate taxes can sometimes operate unfairly and' prompt the sale of family farms. According .to the USDA the nationwide average of production a8sets per farm was an estimated $160,000 on January 1, 1975, and the average farm contained 370 acres. The aver- age return on the market value of equity in farm production assets was only 5.8 percent in 1974. From 1969 through 1971 it was below 3.5 percent, although in 1973 it was 10 percent. You can look at the chart on page 24 of my statement which outlines some of the statistics involving farms. `The key here is to pinpoint the solution. We should tie the valuation of farmlands to the earnings. We are talking here about an estate tax that is based on the value of a farm as a farm, and we think that will be the answer. But there is a very real danger that this committee must consider in doing this. The USDA has warned that many of the proposed solu- tions will actually prompt wealthy people to invest their ,estates in farm real estate to avoid estate taxes. This will create farm tax shelters all over again in the estate tax area, and it will have a very bad effect on legitimate farmers. It `will create entry barriers for legitimate faimers to get into farming Young farmers without having family background in farming will be blocked because the price of land will be brought up by the `wealth individuals looking for a place to invest and receive the benefit of `the estate tax forgiveness due farmlands. The concern over the increased average age of the' farmers seems to hithere very significantly. Second, the rush of wealth investors to look for farmlands as an estate tax shelter will exacerbate the existing valuation problem. This is the defect in the several `bills that have been introduced in Congress. Even with the 5-year recapture, even with a 10-year recap- ture, or 50-year recapture, the fact of the matter is that wealthy individuals can invest in farmlands, and even if it is 50 years later produce a tax free transfer to their heh~. This is very much like a genera'tion skipping trust, but even 5 years is a short time `for wealthy individual~ to buy up land and hold it in order that their estates receive tax free treatment. You have to remember any reform focused in this area is a land use decision that this committee has to make. If we are in favor of land use and we are in favor of preserving the small family farm in spite of the general acceptance of the highest and best use from lands, then it seems to me we ought to adopt some kind of current use valuation system. In the property tax area States have begun to do this all over the country The problem here again is that States are finding that wealthy speculators are moving in to take advantage of the land use valuation, bidding up the price of farmland all over again. Some States are `beginning to try to solve this problem with a concept called development rights. They ~re beginning to `allow farmers to transfer or sell their rights to develop the lands to the State or local agencies Speculators unwilling to part with their development rights don't get the favorable treatment This will insure that legitimate farmers who want to st'ay'oi~ the land can döso~ and it will keep specu- lators out. ` ` ` I would suggest that the Federal Government `could adopt the same kind of concept in the estate tax. The family desiring to continue farming and to pa~ an"estate tax based on land use value could transfer PAGENO="0372" 358 its development rights to the Treasury in satisfaction. of the portion of the tax which would otherwise be due on the value of those develop- ment rights. If the `heirs then decided to abandon the farm they could buy back the development rights in any' future year by paying the amount of estate tax forgiven plus fair market interest. Despite the conveyance of the development rights, the family could retain the right to sell off small parcels from time to time to meet operating expenses. If our concern is for farm estates, and for preserving farming, it seems that this' proposal would mean that farm areas would not pay this steep estate' tax at all so long as they remain in farming. Yet it should not entice too many others into'land speculation as a complete forgiveness ~f'the tax `or increased farm exemption would do. If the heirs decide to take the "vow of poverty" that small farmers seem to have to take, it seems that we `should not tax them on this illu.~ sory paper wealth. But if they dO decide to sell off, we have to keep in mind that a $500,000 farm in the hands of huirs that want to sell it to, a developer represents a substantial wealth, and we shottld tax that. In conclusion, estate and gift taxes are our most neglected taxes. Since World War II `we have' significantly bro'adened"the base of the income `tax and the payroll tax. While Federal revenues continue to fall below anticipated outlays; this committee should be looking for ways of broadening the"Federal tax base. Estate and gift~taxes-our most progressive and least distorting taxes-are prime candidates for addi- tional revenues.: The structural changes we have outlined will move in that direction. Special hardship problems in the estate tax area should be dealt with specially and not used as a peg for wholesale reductions of the estate taxes of the Nation's wealthiest 10 percent. `In estate tax relief, as elsewhere, there is no free lunch. To avoid larger deficits, `any revenues lost by granting relief to those who inherit wealth will have to `be made up by increased taxes on working individu- als or going business concerns. Given the choice, this committee should opt for taxing inherited income over added taxes on earned income. The CHAIRaAN. Without' objection, the full statement will be ap- pearing in the record. [The prepared statement follows:] STATEMENT OF ROBERT BRANDON AND WILLIAM PIETZ, PUBLIC CITIZEN'S TAx REFORM RESEARCH GROUP Historically, the initial purpose of the estate and gift tax was to raise federal revenues. These taxes accounted for 7% of budget receipts in 1939, 4.4% in 1941 and 2% or less in the years since 1942. Estate and gift taxes are projected to bring In $4.6 billion or 1.5% of revenues in FY 1975 and $7 billion or 1.3% of rev- enues in FY 1981. While its revenue contribution continues to fall, estate and gift taxes do provide needed federal revenues. Assuming we are stuck with `high taxes we have a choice of whether to shift even greater burdens on to people's work incentives through social security and income taxes. . . or taxing the amount which adults can inherit from their parents. Given the choices, this committee should be looking for ways to increase estate and gift tax revenues. At' a very minimum any estate `and gift tax reform pack'- age should be sufficiently well balanced as to not reduce tax revenues. Advantages of estate and gift taces Including social security tax and numerous income tax preferences, `our federal tax system is not very progressive. But according to the Treasury's 1969 studies roughly one-third of the progressivity thiit does exist is the result of the estate PAGENO="0373" 359 and gift taxes-j-taxes that are collected almost exclusively from families with annual incomes well over $20,000. The estate tax is a relatively simple tax which can even-handedly tax much of the property which escapes taxation under the income tax due to all the in- come tax preferences which have been enacted year after year. Large inheritances ma~ often dull the beneficiaries' productive incentive. Es- tate taxes also have the beneficial side effect of providing that people In each new generation are more equal at the start. of the race to acquire possessions. Flnally~ as a source of tax revenues estate and gift taxes interfere least in the behavior patterns of individuals. And their impact on, those receiving, gifts ar~d bequests seem to be most fair. One person trying to beat the cost of living works hard to earn $60,000. He pays a substantial tax on that Income and supports himself and perhaps a family on what's left. His neighbor Is left a $60,000 bequest but pays no taxes at all on that Income. Both individuals have to pay the same bills for food~ clothing, a mortgage, health care and other expenses, but the person receiving the windfall gift or be- qu~st pays with non-taxed dollars and his working neighbor makes due with what's left after taxes. In view of the foregoing, the estate aild gift tax seems to be our "least bad" tax. Any attempt at reducing estate taxes as a source of federal revenues would seem unfortunate. And reducing their effect on estates generally is unneeded. Who pays the estate taai? Contrary to generally held beliefs about death taxes, a very small number of very wealthy estates pay them. 60% of estate and gift tax revenues come from the wealthiest two-tenths of 1% of all decedents. (In the income tax, 60% of revenue comes from the top 20% of all taxpayers.) Estate tax revenues in fact, equal only 5% of the total dollar value of all death transfers. Based on 1978 figures, less than 9% of decedents (173,000 people) were required to file returns. Of these, only 121,000 or a little over 7% paid any estate taxes at all. Today, when we talk of paying estate taxes we are still speak- ing of less than 10% of all the estates in the country. Any general liberalization of the present estate tax will therefore provide tax relief to the wealthiest 10% of all estates. If this committee desires to further reduce federal revenues, perhaps the 90% of our taxpayers who struggle during their lives to make ends meet and can leave no taxable savinga at all are better targets for tax relief. Distribution of weaith Even as a tax on the very wealthy, estate taxes have had little impact on wealth distribution. In 1978, there were an estImated 200,000 U.S. millionaires. This may be more a tribute to the productiveness ef our economic system than to the individuals themselves, for an extensive Federal Reserve System survey in 1966 reported that 59% of those with annual Incomes of $100,000 or more Inherited "a substantial por- tion of their wealth." The same survey found that the wealthiest 5% of consumer units owned 53% of all private wealth and 86% of all publicly traded stock. It was estimated in 1973 that there were more than 1,000 individuals with a net worth in excess of $50 million, including a number of "billionaire" families. Low effective rates In contrast to moves to lower estate taxes, the tax could be more progressive without hardship. Analysis of the Treasury's 1969 and 1973 Estate Tax Returns show millionaire estates paying federal estate taxes amounting toroughly 21% of their net estate (about 25% when state and foreign death taxes and others are included). The vast accumulations in the $10 million ahd above category, averag- ing $25.2 million, paid even less, 17% of net estate (nearly 21% Including state, foreign, and other taxes). The Treasury's 1969 Tax Reform Studies and Pfopo- sals show effective tax rates on total transfers during both life and at deaths, for the $5 million and above category, to be 2.2% for married descendants and 39.7% for nonmarried. The Present rate structure Even though the tax is by its nature progressive, the rates need tightening The person who happens to be the sole-beneficiary of a $1 million estate Will pay a tax of $270,000 or 27% and, of course, for smaller estates the rates start out at only 8%. By contrast workers start out with an income tax rate of 14% plus PAGENO="0374" 360 payroll taxes of about 6% and the rate reaches 50% when taxable income reaches $50,000. rrhe existing marginal estate tax rate climbs reasonably quickly from 3% on $5,000 taxable estates to 25% on $50,000 but it then climbs too slowly reaching only 38% on $1 million, not reaching 50% untIl $2,500,000 or 77% until $10 million. Even if you alleviate the effect of telescoping the bequest into a single year by applying the 5-year income averaging available on the income tax receiving a bequest is still a far easier way to meet the cost of living than is working, (e.g., if a $1,000,000 estate-which now pays a marginal rate of 38%-were divided by 5 It would yield $200,000 which Is taxed at 70% under the income tax). The estate face ecoena-ption The fact that the exemption has scarcely been looked at since 1942-or since 1916 when it was $50,000-(lgnoring the 1948 marital deduction enactment which enlarges the exemption), hardly justifies any increase now. From 1916-1970 the income tax at almost every level jumped at least tenfold and since 1938 the social security tax has gone from 1% to 5.85%. Since 1927 federal gQvernment expencli- tures have gone from about $25 per capita to far above $1,000 today. The simple truth is that our ether taxes were upgraded during and after World War II to parallel the growth of government while estate taxes have been ignored. A credit in lien of the ewemption Roughly 90% of all estates are already protected by the $60,000 exemption. Any increase in it benefits relatively large estates. And given the progressive tax rates, any exemption increase gives the greatest relief to the wealthiest estates. Today the estate tax raises less than $5 billion. According to Treasury esti- mates furnished to the congressional research service proposed exemption in- creases will signftlcantly cut down that revenue. Ohanging the exemption to a credit however, would keep the same number of estates off the tax rolls at a con- siderable savings in revenues. (See Tabl~ I) Of the $4.1 billion 1973 estate tax revenues only about $75 million came from gross estates under $120,000 and $400 million came from gross estates under $200,000. This suggests that a vanishing exemption which phases out entirely in upper brackets (say $1 million) is a very inexpensive alternative to straight ex- emption increases. ESTIMATED REVENUE COST OF INCREASED EXEMPTION LEVELS, AND OF SUBSTITUTING TAX CREDITS ACHIEVING SAME TAX-FREE NET ESTATE Tax credit Change in tax revenue from required to achieve same Change in tax revenue from Tax-free net estate achieved through directexemption present law (billions) tax-free net estate present law (millions) $60,000 (present Iaw) $100,000 exemption $114,333 exemption $131,000 exemption $150,000 exemption $163,333 exemption $197,667 exemption $200,000 exemption 0 -$1.0 -1. 2 -1. 4 -1.7 -1. 8 -2. 2 -2. 2 $9, 500 20, 7~0 25, 000 30, 000 35,700 40, 000 50, 000 50, 700 +$740 +90 -400 -700 NA -940 -1, 320 NA Source of revenue estimates: U.S. Treasury Department and Congressional Research Service. Integration of estate and gift taa'es Under present law estates and gifts are taxed under two separate hut simi- lar progressive tax rates. The gift tax rates are three-fourths of the estate tax rates. The two progressive rate structures allow those with great wealth to split their wealth by givilng away half of It during their life and leaving half at death. Taxing each half at the lower ends of each tax rate provides significant tax sav- ings. And the greater the wealth that is split, the greater the tax savings. For in- stance, total gift and estate taxes on taxable transfers of $1 million split evenly between a gift and a bequest would be $247,000 as contrasted to $325,700 were the entire transfer made by bequest-a savings of $78,645. Splitting $10 million produces a tax savings of $1,768,850. PAGENO="0375" 361 ~ The glftánd estate thx~ should be combined or tht~grated and the rate on gifts should ~ie equalired v~1th the rate on estates Total transfers of wealth would be taxed at one tax rate wbetber given away during life or at death There is no justification for setting a lower rate on gifts to stimulate lifetime transfers or for allowing decedents whose large gifts once placed them in a high gift tax bracket to start all over again in the very lOwest brackets iii computing estate taxes. As noted below the present rate differential has not stimulated much gift giving (especially when compared with what would perhaps occur anyway. ) Gift tax revenues approximate only 10% of the estate tax revenues. Lower. rates oi~ly sub- sidise the knowledgable few who can afford to part with property. This minority's effective tax rate tends, to approximate 5d%-60% of comparalle persons who hang on until death. Gifts don't promote broader distribution of wealth since they rarely occur outside the family unit and claims that they place capital in younger and more vigorous (and less experienced) hands are baseless, window- dressing-especially since gifts of trust Interests and non~controlling business interests are common Integration should make unnecessary the present litiga tion spawning rules on gifts in contemplation of death By Integrating the two taxes the cash spent to pay the tax on lifetime trans fers would be added back into the estate ( grossup ) This will eliminate the existing abuse whereby a gift (even a death bed gift) of c'ay $5 000 000 by one in the 77% estate tax bracket will yield a tax saving of $1,300,000. Such a gift two months prior to death reportedly saved Mr I DuPont $10 000 000 in taxes on his $176 000 000 estate The absence of ~`gross up confers progressively higbei per centage benefits as the taxpayer's bracket increases. Past gifts made prior to the effective date of Integration should still count In determ~ulng what bracket Is available. This In effect simply amounts to a question of what rate will applyto transfers made tomorrow. Tax rates frequently change over the years and no one will have been harmed by justlfiable reliance that rates will never change Integration was first proposcd by the Truman administration Unless this is done, Integration coul4 cause revenue losses In the short run. In the long run It could raise gift an4 estate tax revenues by $5 to 10%.. I~itegration~ and the ceemptions Given the present dnal system, the exemption is actually too large. Thanks to the annual gift exclusion of $8 000 per donee ($6000 for couples) and lifetime gift exclusion of $30,000 ($60,000 for couples) a couple can transfer $540,000 freeof any trana1~er tax to 3 children over a 30 year period But this exemption operates unfairly since It Is used only by a few of the wealthiest and most knowledgable taxpayers Based on a 1957-59 sample 52% of decendents with estates over $1,000,000 had made lifetime gifts but only 10% of those with estates under $800,000 bad done so. [f there is to be any increase in the estate tax exe~npt1on it should be offset by repeal of the lifetime gift tax exemption This would naturally result from uni ficatlon of estate and gift taxes Moreover the $9,000 per donee yearly exemption was Intended to cover casual Christmas and anniversary presents etc and theie fore should not be available for gifts of stock, trust Interest or partnership inter ests which smack of estate planning, not~casual generosity, Generation skipping trnsts Vast amounts of wealth can escape estate taxation by transfers in generation skipping trusts. Wealthy individuals use the trust to skip the ta.x on all or part of the estate upon the deaths of the surviving spouse, the children, and, in ex- treme cases even the grandchildren. Through these trusts, the estate tax can miss two generations while the spouse and children enjoy most of the benefits of the estate while they're alive Generation skIpping trusts are utilized primarily by the very largest estates further reducibg the progressivity of the estate tax Estate tax returns filed during the 1957-1959 period show that in estates of over $1,000,00, 25% of assets were transferred in generation-skipping form (19% in trust and 6% outright), but that only 9% of the assets in estates of lec~s than $800,000 were transferred In that form. In the over $1,000,000 group, about 80% of all assets Involved In trust arrangements were transferred on a generation- skipping basis Of the decedents who had estates of over $2000000 and who used trusts, only 25% used trusts that were not in generation skipping from 77% of the decedents wIth estates of less than $500 000 dId not use such trusts Generation-skipping transfers (whether or not in trust) should be ttxed to produce enough tax equIvalency to other transfers In this regard, we would sup- PAGENO="0376" 362 port the 1969 Treausry proposals or any other mechanism achieving the same goal. The complexity of doing so is sizeable bu1~ ~not materially worse than the existing complexity of ingenious generation skipping transfers takjng into account discretionary trusts, power of appointment, the rule against per- petulties, etc. Taxpayers don't complain about thts complexity because It can frequently be availed of to avoid estate taxes for close to a century (usually for the life span of the last surviving grandchild or great grandchild plus 21 years). By some estimates this might increase estate tax revenues by 10% or more in the long-run. UapitaZ gains at death Presently, appreciation of capital assets are taxed at capital gains rates when sold. But if these same assets are transfe~~red by gift Or bequest that capital gálii escapes taxation forever. If the heir or donee sells that property, that apprecia- tion still completely esckpes Income taxation and only appreciation after the transfer is taxed. This Is the most glaring weakness In our present tax structure today. It pro- vides enormous tax advantage for the very wealthy who can afford to hold on to property holdings and stock portfolios until they die or give theth away to their children before death. Enough has been written on the subject but It Is time the Congress came to grips with this glaring tax inequity. It Is perfectly possible to reform this area while addressing the specific problems surrounding certain family held assets such as primary residences, and small farms or businesses. Our concern for these assets should not deter solutions to the overall problem-a tax problem that dwarfs most others in magnitude. The Treasury has estimated that in some recent years 40% to 50% of estate values has beeh untaxed capital gain. By this analysis, $15-20 billion of gala went untaxed annually. Failure to apply a capital gains tax at death cost about $1.5 billion in 1975, and will `cost over $7 billion in FY 1977. This largely accrues to the benefit of a very narrow group. Analysis of Treasury data for 1978 shows that 5.1% of taxpayers r~ceived 84% of all realised capital gainA. Probably a smaller number pass on unrealized gains at death. Long o'vercZue reform Not tating gains at death obvioirdy produces an undesirable "lock-In" effect sihce taxpayers hold their assets until death Instead of releasing the funds for possibly more productive uses which might pay a higher prê-tax market return. Those who can afford to bold their assets are better `oft `than less wealthy individuals who must periodkally sell assets to raise cash or those who p~ust build their estate throàgh sa1~ry income.. While some capital gains are attributable to inflation, some capita' `~1sset~ such as real estate have appreciated faster that the Consumer price hl~ex which means that the owners' purchasing power has inereased~ Also, owners forced to pay a deferred tax on capital'gains would still be in a' better position than people who pay taxes annually on interest on fixed income debt securities, and `they pay at one half the ordinary rates. No adjustment is made in their tax bill for the inflation-induced loss of purchasing power represented in `their Interest returns. Moreover, the purchase of many capital assets Is fliTan~ed by ~lebt Paying off such debt later in cheaper dollars produces an inflation-induced profit, which,, of course, Moreover, the purchase of many capital assets is financed by debt. Paying off such intolerable complexity, while over-compensating for it in this area produces an unjustifiable distortion. Eclief for certain famiZy assets Propo~el to tax capital gains at death such as the 1969 Tre4sury proposal, contain `an unlimited marital deduction, an orphan child exemption, a specific exemption of $60,000, exclusion for life insurance and household effects, 10 year averaging provisions and extension of time for making payments. These seem reasonable. The `$60000 would `protect any good sized family residence from' the tax. Farmere and small business owners could be protected `from any hardships by utilizing the special valuation methods discussed below. In our concern for small family estates we should not hose sight of the fact that these estates are not really small. They are only small compared to very large estates. But compared with the 90% of i:i.s. Adults wb~ leave no taxable estates at all, the recipients of these bequests are very well off. Now, as a policy matter, Congress would not `want to see families f~r~ed to ~ell the family home or business just to pay the tax owed. But concern over ilhiquldity PAGENO="0377" 363 is a separate issue and sliOtild not obscure the fact that by far the largest item of appreciation in U.S. estates is marketable securities. Taxable estate tax returnsflledduring' 1986 reported gross assets of $18.8 Ml- lion eotnposed of the ~bllow1ng: TABLu II Taxable estate tax returUs filed during 1966 reported gross assets of $18.8 billion composed of the following: Real estate: Bflhions Primary residents $0. 7 Other 2. 7 Bonds 1.4 Corporate stock: Praded ~ 6. 7 Closed corporations . Unspecified 1.0 Cash_ 2.1 Notes and mortgages 6 Life insurance . 8 Annuities . I Trust and remainder interests 1. 3 Noncorpor~te busihes~ assetS . 5 Household goods and othe~r_T,,~_~ . 3 Nova-At least $14,000,000,000 of the above involve no liquldjtyproblem. Thc unUmjted charitable deIuction ~I'he case of MI~s. ~1lsa Mellon Bruce w~ho died In 196~ and ?aida tax bf `under 1% on her $570 million estate because she left her estate to the Mellon Founda- tion is disturbing. So is the fact that in 1966 five large estates left a total of $200 million to charity while paying only $8 million in ta~~s. A case can be made for retaining the unlin~ited charitable deduction for gifts n~ade to public charities. However, private foundations sometimes perpetuate private control of wealth while making legitimate charitable distr1butioi~s on~r reluctantly. The Treasury will give up 77 ~nt~ on tbe~lol1ar, but that `money often `will be paid out to charities at no more than the prescribed 6% rate. In recognition of the undesirability of placing too `many Inflexible operating restri~tlons on foundations, our income tax laws simply pltt~e a lower ceiling on the charitable deduction for gifta to private foundations as distinct from public charities. By analogy, deductions for contributions to pri~vatefoundations sho~ld be limited at least to `.50% of the adjusted gross estate less the marital deduction. The deduction creates other inequities~ As it currently exists~ the tax benefits from tim charitable deduction are more a function of the decedent's wealth than of h1s~gen~erosfty.;'If tho $25 million estate donates $250,000 or 1%, the tax~savings can amount to as much as $192,500 (77~ on the dollar), while the decedent with $1 million who gives 25%#-again $250,000--can reduce his taxes .a maximum of $92,500 (about 37~ on the dollar). And estates in the bottom tax bracket, po matter what their generosity, are reimbursed only three cents on the dollar. Conceptually, substitutlng,a credit for the deduction will make the tax more progressIve ,and treat all gifts even-handedly without impairing gift-giving incentives, , The marital deduction ` `, As part. of an. overall estate and gift tax reform pa~kage~ we would support a full (100%) marital deduction in reeognlti~n of the joint and unseverable con- tributions made by spouses in building an estate. ThiS would alleviate the special problem faced by farm wives `and "is a logbrnl e~cception to the proposed income tax on capital gains at death. However, the cost of a full estate tax deduc- tion might approximate 15%-18% of the total estate tax revenues in the short run and half of this in the long run. (As surviving spouses eventually die with larger estates.) Erthi setting the ceiling at $100~000 plus 50% of the remainder might approximate $500 million in lost `revenue. A ceiling would however, minP misc the estate tax relief' that would be accorded those with great accumulated wealth who marry very young spouses in their later years. The present 50% marital deduction provides rate splitting benefits under the graduated tax structure. If the spouse who owns most of the family's property happens to die first, half of that property will be taxed immediately and the other half will be taxed when the surviving spouse later dies and passes it on. Each half PAGENO="0378" 364 will fall into lower brackets than the entire estate would if it were taxed all at once. But if the impecunious spouse happens to die first then the entire estate will be taxed all at `once when the property-owning spouse later dies. No rate splitting applies so the tax is accidentally higher. Community property couples have an advantage because they automatically own only half. If the wealthy spouse in a non-community property estate tries to give half his property to the other spouse before death he must pay a gift tax on half the property transferred (the gift tax marital deduction is limited to one half of the gift,) The complete estate and gift marital deduction recommended by ALl and by the Treasury in 1969 permits all couples to do exactly what community property couples are able to do. Before death, they can transfer half of their property Into the husband's name and half into the wife's name. Thus, each spouse can leave his or her property directly to the children and thus be assured of rate splitting. Or a husband, for example, may wish to transfer all of his property tax-free to his wife at death. This would be advisable where the wife needs the property for support and may consume some of It. Otherwise the tax at death will be relatively large due to the absence of rate splitting. Credit for State death tacees We should repeal the credit for death taxes paid to the states. Even under present law there is no comparable credit for gift taxes. The death tax credit was enacted during the 1920's so that states would not compete to att~aet wealthy resi- dents but its effect Is now limited because the amount Is limited to 80% of the relatively low federal rates In effect In 1926. The credit is zero for taxable estates under $40,000, only 1.6% ($400) for a taxable estate of $140,000, but a surprising 16% ($1,082,000) for a ~$10 million estate. What about family farms and businesses? The exemption should not be Increased for all taxpayers just to assist small businesses or farms. A~ a matter of perspective, for e~ample, 1966 IRS lata showed that total returns filed showed gross assets of $18.8 billion. Untraded closed corporation stock totalled not more than $1.9 billion, non-corporate busi- ness assets totalled $.5 billion and "all real estate other than primary residence" totalled $2.7 billion and by no means all of this was farm real estate. SectiOn 6166 installment payments § 6166 presently provides for 10-year Installment payments of estate taxes In hardship eases. However, this pro~dsion is almost never used because the execu- tor who Is empowered to request relief under this section is made personally liable for the ten year installments. According to one IRS district officer in Omaha only about 3 out of 1,000 farm estates ever request relief under § 6166 and the IRS almost routinely grants the relief except for obvious cases of fraud. The liability for § 6166 installment payments should attach to the state assets as a lien. This one reform would do much to alleviate the estate tax burden of the small family estate. Insurance In addition, every commercial attorney knows that much of the estate tax burden of small businesses and farms can be alleviated by using life Insurance proceeds to pay the tax. Insurance can easily be arranged so that the proceeds are n~t taxable as part of the decedent's estate. And as a matter of political realism this committee Is unlikely to change this generous treatment. Even with this help, many farmers and some small business owners are treated unfairly by the estate tax. But their problem Is one of valuation. That problem should be dealt with narrowly rather than by an across the board exemption hike. Small business estates A small business owner often has good reasons to fear the absence of any uniform standard In the code or regulations by which his business will be valued. Reviews of the hundreds of litigated cases show: (1) The IRS almost always selects whatever valuation method produces the highest figure. (2) Taxpayers often fare poorly due to poor preparation and Inadequate appraisals. PAGENO="0379" 3~5 (3) `Courts frequently "split the d1fferent~e" in very unscientific compromises. The anguish occasioned by this will not be solved by increasing the ezemp- tion-especlally since the huge cost (a $150,000 ex~mptlon would cost an addi- tional $1.7 billion) makes it likely that a very large Increases will not be afford- able. A small closely held business Is usually valued at a multiple of less than 10 times its annual after tax cash flow by would-be buyers. Assume the tax Is from 3% to 77% of this value. By definition permitting 10-year Installment payments should enable the heir to pay off the tax from the business cash flow without sell- ing the business. We believe-as a few legal practitioners have testified before this committee in prior years-that businesses are seldom sold for any reason other than the unwillingness or Inability of heirs to carry on. But the committee may be justified in considering a limit on the multiple at which the IRS can capitalize earnings for estate valuation and technical adjustments In ~ 6166 and 303 to assure their availability to family businessee. Family farms and the estate taco We believe the farm problem is a more severe one because farms are land intensive. U.S. farm real estate values have been soaring. They increased 25% in 1973 and 14% in fl~74. Clearly, the fair market value of land if sold to a developer exceeds its farm use value. According to `USDA surveys the average value of all farmland in the U,S. reached $370 per acre by March 1975 but land transferred to Industrial uses brought $1 872 per acre subdivision land brought $1 574 and land converted to rural residential brought $974 (In 1975 average farmland value per acre varied greatly geographically e g, $2 500 in New Jersey $600 in New York, $500 in kansas, $240 In Texas). TaXIng this. Inflated paper value can create a prQblem especially since farm estates are illiquid Almost 80% of farm estate assets are In land and machinery compared with an average of 20% for all U.S. estates. The pro 51cm in perspective But the problem should be kept In perspective. The transfer of land out of farming which exceeded a rate of 100000 farms per year until the late 1960s has steadily declined and equalled only 26,000 farms in 1973 and a majority of these sales were probably made for reasons other than estate taxes USDA econo mist Fred Woods `concluded In 1974 that estate taxes are "not yet a serious problem for most types of farms And the number of acres planted In the U S (1,060,000 000) was actually the same In 1970 as it was In 1940 which may suggest a transfer of land to more ethclent larger farms. Moreover the USDA Balance Sheet of the Farming Sector 1975 states `sale of land going into nonfarm use Is not a major factor In setting the price of land except In 1~olated instances. Most land transferred In 1974 was purchased for farmIng purposes and was expected to be paid for with farm Income." The illiquidity problem Nonetheless estate taxes can sometimes operate unfairly and prompt the sale of family farms According to the USDA the nationwide average of production assets per farm was an estimated $160 000 on January 1 1975 and the average farm contained 870 acres. The average return on the market value of equity in farm,productlon assets was only 5.8% In 1974. From 1969 through 1971 it was below 8.5% although In 1973 it was 10%. The T3SDA publication Farm Costs and Returns (1968) lIsts `representative' figures for "viable" one-man farm units. The following is ii random sample: A 40 cow New York daIry farm had 250 acres and total equity of $81,000 in 1968 and earned ¶12 100 a 60 cow Wisconsin daily farm bad 210 acres $111 000 equity and earned $18,000; a New Jersey egg farm had 10 acres and $52,000 equity and earned $4,600; a Georgia broiler farm had 65 acres and $26,000 equity and earned $1,700: a corn belt hog and beef farm had 92 acres and $175,000 equity and earned $12,000; a corn belt graIn farm had 324 acres and $227000 equity and earned $11,000: a Mississippi cotton farm had 1,000 acres and $440000 equity and earned 838.000: a southwest cattle farm had 11,690 acres and $220,000 equity and earned $7,300. The above earnings were before income taxes and mortgage debt payments, if any, and, of course, the equity values would be much higher by 1975. PAGENO="0380" 366 Substantial technical advances in machinery (principally as increase In the number of rows which one tractor can plant) has recently increased the desirable size of one-man farms. Technically optimum one-man farms can vary from 1,900 acres for a Montana wheat-harley farm (laud value $~4~,000 in 1973) to 200 acres for a California vegetable farm (1973 land value $400,000). The actual average size for most types of farms is still below the optimum. According to the USDA expansion has led to "a substantial increase in debt to asset ratios." The debt ha,s been collateralized by Increased land values. These and numerous other USDA statistics suggest that some farmers espe- cially those with existing mortgages, or those in areas close to urban develop- ment are reaping small cash fi~ws even though they are land-rich. The chart ott the following page is a 1973 statistical profile of farms and potential estate tax liability. TABLE Ill * 1973 . number of Percent of 1973 Maximum Average farms in Gross sales 1 United States total farms in United States average net equity . possible estate tax estate tax paid Under $2,500 707, 000 25 $44, 000 $2,500to $5,000 494,000 17 61,000 $5,000 to $10,000 246,000 9 79,000 $1,600 $480 $10,000 to $20,00Q - t25, 000 12 117, 000 8,750 4, 500 $20,000to $40,000 588,000 . 21 177,000 25,000 11,050 $40,000to $100,000 355 ~ 12 281 .000 si,ooo 23,930 Over $100,000 - 115,Q0Q ,. 4 685,000 19,450 . 116,180 Total 2,830,000 100 1 Net income before income taxes and debt payments frecluently is from 20 percenttO 40 percent of gross sales. Pinpointin~g the aoh~~tion The key to any solution to the farm problem is to tie estate va1i~ation to the potential earnings which the heir will have available to p~y the tax. An estate tax based on the value of the farm as a farm would be the answer. But as the USDA has warned, niany su~h proposed solutions are vé~y danger- ous. They a~e likely to prompt the wealthy to invest their estates in farm real estate to avoid estate taxes. This will further innate laud costs creating entry barriers for the legitimate farmer and exacerbating the existing valuation prob- 1cm. Tbi~ Is the principal defect of the ukveral bills which would value farms at their farm-use value Instead of fair market value provided the heir keep the land in farming for, say, 5 years. 1~ven . if the land had to remain In cultivation for 50 years, farm land would still be an irresistible tax haven for the wealthy who wish to transfer enormous appreciation to their grandchildren free of totx.. It would be just as attractive as a generation-skipping trust. Any such opportun- ity for estate tax shelters would be just as damaging to legitimate farmers as present income tax .shelters. ReUeffôr far'm8 iaa Zand nse dcci sion By allowing a lower valuation Congress would be departing from the tradi- tional view of both economists and business planners that land should be dedi- cated to its highest and best use. This would be a conscious decision to adopt a form of land-use planning designed to preserve farms. Many states and localities have already begun moving in this direction. Some sllow farm use valuatien to be used for property tax purposes, However, this has led to spoculative land purchases by wealthy outsiders which hurt the farmer. To avoid this problem some localities have been allowing farmers to sell their development rights to the local government or to transfer their development rights to the local govern- merit in exchange for lower property tax valuations. Speculators unwilling to part with their development rights don'4 get the favorable treatment. The federal government could adopt the same concept in the estate tax. The family desiring to continue farming could pay an estate tax based on land use value and could transfer Its development rights to the Treasury in sath~faction of the portion of the tax which would otherwise be due on the value of the de- velopment rights. They would only qualify if as under section 61016 the farm was a major portion of the estate. If the heir ever decided to abandon farming they could buy back the development rights in any future year by paying the amount of the estate tax forgiven plus fair market interest. Despite the conveyance of PAGENO="0381" 367 th~~ developm~riz rights the family could retain the right to sell Off smell parcels from time to time. Relief frwfamities wlu keep their farms This would mean that farm heirs would not have to pay a steep estate tax at all so long as they remained in farming. This is more generous than proposals such as President Ford's to make them pay the tax but only over an extended period. Yet it shouldn't entice too many non-farmers into land speculation-as a complete forgiveness of the tax or increased farm exemption would. Under present law a farmer could, in fact, deed his land development rights to a charitable or conservation organization.' Since this, would yield a charitable deduction equal to the develop~nent rights the estate tax would in effect be baSed on the farm use value of his land. But, of course, his heir couldn't ever get the development rights back. The foregoing proposal would remove this drawback. Conclusio~s Estate and gift taxes are our most neglected taxes. Since World War II we have significantly broadened the base of the income tax and the payroll tax. While federal revenues continue to fall below, anticipated ~utl'ays, this committee should be looking for ways of broadening the federal tax base. Estate and gift taxes-our most progressive and least distorting taxes-are prime candidates for additional revenues. The structural changes we have outlined will move in that direction. Special hardship problems in the estate tax area should be dealt with specially and not used as a peg for wholesale reductions of the estate taxes of the nation's wealthiest 10%. In estate tax relief, as elsewhere, there Is no free l~ncb. To avoid iar~er de- ficits, any revenues lost by granting relief to those who Inherit wealth will have to be made up by increased taxes on working individuals or going business con- cerns. Given the choice, this committee should opt for taxing inherited income over added taxes on earned income. ` ` The QEtAInMAN. Is there any panelistwho would like any additional rebuttal time? We will be happy to hear you if you do, otherwise we will proceed with questions. Let me first commend all of you for a very excellent statement. I think we have built a good record. Let ms.ask very briefly of those who represent the American `Bank- ers Association, in proposing an additional estate tax on appreciated property held at death, why do you not have a progressive tax on ap~ preciation, instead of'the fiat tax you propose. Mr. BUmLA.. We have tried to duplicate the tax the wealthiest es- tate would pay under the capital gains tax proposal. That would be 35 percent, but it would be deductible against the Federal estate tax. Therefore if a man were in the 60 percent estate tax bracket he would effectively be paying 40 percent of the capital gains, so we simply said 40 percent net after tax cost, not after the estate tax rate, times the 35 percent capital gains tax rate. That gives you 14 percent and that is exactly the amount the wealthiest estate would pay under capital gains tax proposaL It is perhaps not completely progressive', `but it is much less regres- sive than the capital gains tax proposal. The ChAIRMAN. On the marital deduction the original purpose was to give parity for common law States. What rationale would you have for increasing that? What purpose would be served by that? Mr. BTvrL1~n. Part of our rationale there was both to recognize in- creased inflation and also to offer an alternative to tbe unlimited mari- tal deduction. As has been pointed out, if the alternative we suggest of the larger of $250,000, or one-half adjusted gross estate were used, plus the credit of p100,000 that we are talking about, we would solve the tax problems for 85 percent of the estate paying a tax, PAGENO="0382" 368 So if you went to a higher marital deduction, an unlimited one, you would be dealing with only the top 15 percent of estates which in turn is, of course, that percentage of the top 7 percent of the people in the country who leave taxable estates. We felt that aid in this area would help the farm situation, butwe felt that our proposal was really as much as was needed. We thought it might be an intermediate posi- tion on marital deduction. The CHAIRMAN. Going to the issue of valuation, if we want to de- termine a commercial valuation, rather than a fair market valuation, Mr. Penick, do you have any suggestion how we might do that? Mr. PENIcii. I am sorry, I didn't quite catch the question. The CHAIRMAN. If we wanted to go to a commercial valuation, based upon the income-producing capacity of a farm, rather than its fair market value, which has created so many problems because that is where all the appreciation is, do you have any idea how we might do that? Mr. PRNICK. If you ever consider that method your problem would be defining what earnings you would then capitalize. There are vari- ations in different kinds of farming or agricultural activities that would vary widely as to the kinds of earnings or as to what earnings multiple would be used to determine the value. It could be done, but it would be very flexible. Mr. CONABLE. Mr. Chairman, would you yield on that? The CHAIRMAN. Please. Mr. CONABLE. My farm friends all claim to lose money every year. Does that mean farms don't make anything? They all live on their investment tax credit? The CHAIRMAN. Mr. Melfe, would you have any suggestion on how we might? Mr. ~ Well, I had in mind the similar technique used in valuing a closely held business, where we work backward to see what its earnings producing.. power is. However, in the case of farms the thing that would bother me is that you should stay with its fair market value-that is, what a willing buyer would pay a willing seller-which would be its value as property, and I offhand don't see how we can solve your problem. The CHAIRMAN. What we wanted to do was get away from that and get to an income producing rather than fair market value. Mr. BUTALA. Mr. Chairman, I would add that you have the same problem with closely held stock because we have situations where there are marginal earnings but a very high book value, perhaps even a very high liquid asset value. I don't see how you could come to a valuation of farm income without applying the same standard to a closely held situation~ and I don't think it can be done, after a great deal of ex- perience in the valuationarea. Mr. PIETZ. Mr. Chairman, we would like to insert that there is a necessary relationship between this question and the provisions under 6166 allowing a 10-year extension to make the payment. We think that in valuing farms or closley held businesses you have to scrutinize the cash flow and determine whether there would be enough cash flow after income taxes from that business or farm to make the tax payments realistically over a 10-year period. Therefore, if you look at the cash flow and whatever multiple you apply to it should in someway be PAGENO="0383" 369 appliedto your realistic prOjection in 6168 Of being able to make pay- ments over 10~rears. We also thiuk that you might look at statistics published each year by the U.S. Department of Agriculture, which show you the average return on types of agricultural property by region. And of course the capitalization that you apply might be the inverse fraction of that rate of return that USDA publishes. That might be, for example, a ceiling. The CHAIRMAN. Thank you. You ha~ve been helpful. Mr. Conable. Mr. CONABLL Thank you, Mr. Chairman. I would like to pick up on what the chairman has said. I think. we have had interesting ideas here this afternoon. I appreciate your coming forward with them. I also see some problems about going to Mr. Brandon's suggestion that we capitalize earnings, because, quite frankly, I think that could end up creating quite a distorted picture of the value of farms, perhaps the same way development has created a distroted picture of such value. Mr. PXRTZ. But you might wish to use it as a ceiling~ looking at cash flow rather than earnings. Mr. CONABLR. Yes; I think you would have to look at cash flow. Mr. PIETz. Yes. Mr. CONABLR. Farms are highly èapitalized and leveraged, so some- times they make a killing but very frequently have losses also. Mr. Pii~rz. It is very clear yOu have to average~ No. 1, over a period of ~ to 10 years, and No.2, you havc'to look at cash flow rather than any concept of earnings. Mr. CONAET~E. We1l~'I think what has been said this afternoon will bear a good deal of study by the committee. I suspect we are getting into a very complex area. The idea that it can be specifically dealt with by raising~the exemption, however appealing that might be, is an idea which is going to have to be tested some, I think, before the committee is going'to be ready. Let me ask Mr. Melfe a question. You, propose, apparently, abso- lutely integrating the gifts during lifetime with testamentary gifts, as far as the tax is concerned. What abOut the public policy back of e~icouraging inthr vivos transfers? We have always given some edge to inter vivos transfers, feeling that this was a desirable thing, that people not feel they have to wait until they die. We should encourage them, in fact, to bring about flows of property that otherwise might not occur until death.. What about the public policy here'? Mr. MELFE. Well, we continue to believe that that should be pursued. A gift giving policy during one's life, especially to one's family, is something that we believe as a matter of policy is favorable. Also, as far as the diffrentiation between the two tax rates. we know that historically that was done in part on the basis that the gift tax is a prepayment of the estate tax that would otherwise be paid if you kent the property until death.' ` Third, I think' that' the' noli~y helps to work against the lock-in problem in the sense that when gifts are made during life oftentimes the clones will take the property and dispose of it by sale. Mr. CO~ABLE. Frequently because he'is in a lower tax bracket? PAGENO="0384" 370 Mr. M~ia~. He is, that is right, so that he can afford to do It at that time. But also when we think of why gifts are made, that is~, generally to help our children, to absorb some of the additional costs ofbuying a house or educating their children, the moneys do get recirculated from the one who would otherwise hold them until death. As I say, our association would favor a continuation of present law, but on the other hand, from a strict tax policy standpoint, one can make little argument about the fact that a unified transfer tax makes sense as well. Mr. CONABLL Thank you, Mr. Chairman. Mr. BUTALA. Mr. Conable, may I add a few comments. I think there aresome advantages still remaining. First, you have the $3,000 exemp- tion, second, when you make a transfer during lifetime you escape subsequent appreciation; and, third, we. are not advocating a uniform rate, but retention of estate tax rates and the same gift tax rates, but retention of estate tax rates and the same gift tax rates, so that the gift tax rate would still be lower. Furthermore, we are not advocating the grossing-up as in the Treas- ury proposal, so you have a swing of about your lifetime incentives, not so great as before, but they are still there. Mr. CONAnLL It also works to help minimize income taxes for a family unit, of course. Mr. I3UTALA. That is what I should have added. Mr. M1~Lr1~. It is my personal belief that if we do come forth with unification the amount of gifts will diminish. Mr. C0NAnLE. I am a little concerned, do any of you advocate putting limitations on charitable bequests ~ Mr. PrETZ. Mr. Conable, we would advocate a limitation on gifts to private foundations. We see no harm unlimited to public charities, but as you are looking at- Mr. CONABLE. Incidentally, they are taxed at 4 percent, not 6 percent. Mr. PIETZ. Six percent' is the payout rate. Looking at the income tax law by analogy, many of us have felt there shouldn't be too many re- strictions on private foundations in terms of their operations. This committee has often had `to deal with such restrictions, we know they can be onerous, so what you have done ifistead is to put a limitation on the percentage charitable deduction for private foundations in the income tax, and we advocate that here. Mr. CONAELL WelL I am somewhat inclined to agree that the estate tax is a better tax to lean heavily on than the income tax. But unless you put some limit on charitable contributions, the heavier your estate tax gets. the more unlikely you are to force property outside the tax law, and that is not something that we should encourage here. You have to strike a balance of some sort. I am frank to say I am not one that is anxious to put limitations on charitable bequests either~ but I want to be sure that the tax law ha's a sufficient balance in it so that we won't be giving the it~centives entirely toward taking property outside the tax law. There should be some per- sonal sacrifice involved in gifts~ even though I think there is a wise public policy in providing some incentive for gifts as well. Usually a gift involves not just a tax advantage, but ~ome sort of a private benefit or a personal benefit foregone. I guess what I am saying is we have a problem of balance here, and I hope we will con- tinue to take these things into account. PAGENO="0385" 371 Mr. Brandon. Mr. BRANDO~. I don't think any of the reforms we have talked about would increase the likelihood of somebody wanting to escape taxation by making charitable bequests at death. In fact the current law right now puts a high premium on giving them away in upper income brackets. I don't think anything we would do in our proposals would make it more attractive. Mr. CONABLa. All right. Thank you, Mr. Chairman. Mr. Btrrn. Mr. Schneebeli. Mr. SCHNEEBELI. Thank you, Mr. Chairman. I came in late I get the impression we are discussing the use of two criteria, one for farms and one for small business Everything I have heard all day relates to farms. Do any of these recommetidationi apply to small business or would you limit their application to farms ~ When we talk about farms are we not also talking about small business? Mr. BRANDON. Yes. Mr. SORNEEBELI. Thank you. Mr. Bux~. Mr. Vanik. Mr. VANI~. Mr. Chairman, at the outset last week when we discussed these proposals for these panels coming here, it was suggested that there would be offered to the Congress a balanced bill, something that would raise the revenues out of the tax program somehow to make possible the kind of things that you are asking for in the change in the estate taxes. Now, I have Mr. Brandon's testimony before me, but did any of the members of the panel have any idea how we can make up for the revenue losses in what you suggest? Is there anything that you have in mind that can make possible an increase in so;me other areas of estate taxation to make possible the adjustments that you recommended so that we have a balanced bill that doesn't come to the Congress with an increase of the deficit? Because I think all of you one way or another have urged that we balance the budget, have urged that we reduce the deficit, I am sure you are for all of those things So now how do you propose that we can have a balanced bill which will provide the relief that you suggest, yet somehow shift the cost of that somewhere in the collection of the taxes that are necessary to do it? Mr. MELirs. Mr. Vanik, let me say on behalf of the American Bankers Association, we look at our suggestions as a whole. No. 1, we are not really asking for anything, but if there are to be any changes, we would like to think that we have looked at it from the vantage point that you have just outlined. For example, to the extent that you might reduce revenues through an increase in the marital deduction, in our view it would be offset by changing the present exemption method to a credit method. No. 2, if you are going to `have any taxation of unrealized `appreci- ation at death; our additional estate tax approach would again take back or bring back into the revenue base revenues that would otherwise l~elost in some of the changes that you have'outlinëd. Third, as for generation skipping, the American Bankers Asso- ciation feels that if a change has to be made,' that it be approached from an exemption standpointi~butwe limit our exemptions so that over 68-872-76-25 PAGENO="0386" 372 a period of time there will be additional revenue taken that is not taken today in such generation skipping transfers. So I don~t have a bottom line for you, but we have looked at it and it is our belief that when yoi~l take all of Your suggestions and add ~them all up, then there is, if anything, a slight decrease in revenues~ ]\4r. BUTALA. I don't know whether Mr. Melfe mentioned unifica- tion as well, but if changes are made we have suggested alternatives and they do come out to be, we think, a b~lanced approach. If there is going to be a change in basis, which we do x~ot advocate, we would sug- gest that it be an additional estate tax on appreciation. I disagree with my colleagues to the left on the amount of appre- ciation passing at death. The figures we have indicated about $16 billiOn passing generally, but if you take inly those through the estate tax system, it is about $10 to $11 billion. The additional estate tax there- fore generates about $1.5 billion. That would go a long way in making up the loss from other proposals. Again we would prefer the status quo, but if you make the changes then we would want a balanced approach, one against another. Mr. WINTER. Can I comment on that now Our principal proposal, of course, is to increase the $900,000 estate tax exemption. That, as I recall, runs in the ~icinit~ of about a $2-bil- lion deficit. I think the revenue from the estate tax is one element that you consider. You consider the elemeti~ts that you are going to get from the other taxes, the other side of the budget picture that you have. Mr. VANIK. Well, you tell me what they are, because I don't know. Mr. WINTER. I understand it is about $2 billion. Mr. VANIK. I know, but how are we going to raise that? Mr. WINTER. Well, let me focus on it and ask the question, or suggest this question. I think that is $2 billion that should not have been taxed. It reflects an exemption of $60,000, where it should have been increased in the last 30 years by the Congress. If the Congress has not increased the exemption, and we now have, because o:f inflation, an additional $2 billion, is it really fair to say that now we are going to give up the $2 billion that is inflation- resulted? Do we focus solely on the estate tax or gift tax to make up the $2 billion, or do we look to total revenue losses, or to expenditures that might be curtailed somewhat? Mr. VANIK. I am going to find it very difficult to go back to my people and say I am going to have to give $2 billion more out of the steelworkers' pocket, their payroll tax deduction, in order to make this kind of an estate distribution. You certainly wouldn't propose that we borrow more. Mr. WINTER. No; I certainly would not. Mr. VANIK. You don't want us. to. go into the money markets, don't want to put us in the deficit. Mr. WINTER. I wouldn't agree with the assumption that simply be- cause you have extra revenue because of inflation that it is equitable to keep it that way. Mr. VANIIt. Well, we don't have enough revenue to balance the oper- ations of the Government. Mr. WINTER. It may not be through the estate tax that you get it, and it may be that some expenditures will have to be curtailed. Mr. PENICK. Mr. Vanik. Mr. VANIK. Yes. You are with National Realty? PAGENO="0387" ~373 Mr. PENICK. No; I am with the AICPA. Mr, V~NIx. Oh, yes, certainly. Mr. PENICE. We have analyzed the five major areas Of estate and sift ta~ reform. In twoof those we basically recominended~ no change, in marital deduction and apprethation of assets at death. With respect to the generation skipping and unified transfer tax, we recommended a change that would increase the tax revenues. I have no way to quantify this. On the last one we take a position which gets to the liberalization of the deferred payment rules. Now, there perhaps is some revenue impact there, although not sig- nificant. We do also recommend an increase in the estate tax exeinp- tion. I would tend to agree ~omewhat with Mr. Winter's commeflt, there is some question in my mind as to whether that amOunt of tax was intended when the $60,000 was adopted in the first place. That is arguable, obviously. Mr. VANIK. Well, at this moment in being confronted with the prob- lem we have in dealing ~vith priorities, I can say at this moment I am very willing and able, and I am glad Mr. Bi~indon treated the question of treating the 6,166 instalh~ent as a lien, I think that is achievable enough, and something we can do. But I am very much concerned with how we are going to raise the moneys that are lost in further tax reliefs for special groups. I am particularly concerned about the real estate situation. In 1973 you have a $15 billion collection in business receipts but 24~,000 partnerships with 1,000,129 partners, and there was a loss of $2.&~i billion. ~This i~all deferred, and now you want to get some more deferral on something that has already been deferred. So I am beginning to wonder when do we begin to tax this real estate income? Do we give it up entirely? Is it in the public interest to do it? Is it sound public policy? Mr. WALSH. Well, Mr. Vanik, I assume you are directing ~tour ques- tion at me. Mr. VANIK. Yes; I am.' Mr. WALSH. You know, you are talking on the one hand about de- ferred income taxation on limited partnerships and on the other hand about, I assume, this proposal to levy-~ Mr. VANIK. In the short time that I have, I have to lump everything together. You understand, my time is expired; you have unlimited time, but my time is expired. Mr. WALSH [continuing]. A capital gains tax on unlimited debt, and 1 think you are falling into the same trap that Mr. Brandon did of equating a capital levy with an income tax. They are, in my judg- ment, in the tax law two very different things. If we start to treat them the same, then we are simply going to treat all estate transfers as if they were income in the current year. I think you and I probably couldn't agree on that, if you feel we ought to go that way. I feel that it would be a great tragedy in this country if we were to go that way. If we are going to treat capital transfers in a given year as income in that year, then there never will be any capital formed in this country at all. Mr. VANIK. Well, all of the people in America have to form capital. I was concerned about people who can't form enough to buy a house, an automobile and can't quite form enough to even pay their taxes. This capital formation thing is pretty uniform, it a~ffeets almost every PAGENO="0388" 374 American, and I think our problems on capital formation stretch over the whole population. It is not a case of capital formation, it is who is going to form it and who ~ and T think under our system we should broaden the base of capital formation, so as many people as possible can enjoy the fruits of capital formation and saving4 I just want to be sure that the system is uniform. Mr. WALSH. I agree with you. Mr. VANIK. And spreads out among the whole population, rather than selected groups. Mr. WALSH. I agree with you, but you said this morning that only 5 percent of all taxable estates were over $60,000. Is that something that you read from some report that you had this morning? Mr. VANIK. Yes. Mr. WALSH. And I assume from things that you have said during the course of the day that you would not be unwilling to see that number grow smaller, so there would be 4 percent or 3 percent. I guess where we differ is that I would like to see that number grow larger so that it would be 80 percent or 10 percent, and if we do differ on that, then we differ on practically everything. Mr. VANJI. Well, I am concerned that what we do is for most of the people, and the 95 percent looks different to me than the 5 percent or the 10. Mr. WALSH. No; but I would like to see the rest of the American public move into that 5 percent. Mr. VANIK. They are never going to do it if the 95 percent are going to pay taxes and the 5 percent are not paying. Mr. WALSH. Well,, let me just cite you one figure here. If you take your realization of gains on death and apply it to real estate and take a $500,000 estate on one hand and a $20 million estate on the other hand, on that $50~,000 estate, a relatively modest estate, you have in- creased the effective rate of taxation from 29.1 percent to 47.9 percent, of the aggregate of capital gains tax and estate tax on that $500,000 asset, which is a 60-percent increase. Now, if you want to call that an upper middle income estate or whatever you want to call it, on the $20 million estate you have only increased the effective rate from 68.9 percent to 73 percent. Thus, typically, taxing unrealized capital gains is going to hit at the smaller estates. Now, Mr. Brandon can say $500,000 is. not a small estate, and I can say that it is in rel~tion to the $20 million, and it certainly iS. But that is where this is going to hit, because of the highly progressive estate tax system that we have now. It is going to hit hardest at that family that just about has an estate at all, and it is going to wipe that estate out. Mr. VANIK. Well, I have no more time now4 I may get `back to it later when I have another chance to question. But I simply want to say that as of now I am not deeply moved toward doing much about this subject, particularly when I don't know how we are going to get the revenue, where it is going to come from. Mr. WALSH. Well, I might point out that I have asked that the committee do nothing oii this subject of capital gains on death. Mr. VANIK. Well, we may have to go the other way in order to develop some. sense of justice, `and among our priorities I don't know if we shouldn't be increasing the family exen~ptions or the exemptions for dependents. We have all of these priorities that are before us, too. PAGENO="0389" Is this greater than thø need to probably do, something for ~ family that is facing the inflationary bite more than anyone else ~ Do we allow enough credit for those that. support dependents? Thtit is ~ of the things that have tQ be weighed along with the great urgent need that is stressed here about preserving small busmes~ and small farm investment. Our job is to legislate and decide where the priorities l~c. I don't want to take any more time to refject on my position, but I am not getting very much convincing in this proceeding. I will try to he here as much of the time a~ possible so I can hear as much of the argument as can be offer~d. Thank you very much. Mr. BURKE. Are there any further que~tions? The committee appreciates the appearance of the panel. Mr. BURLESON. Mr. Chairman, may I just comment? Mr. BURKE. The gentleman may. Mr. BURLESON. I am surprised tltat Mr, Vanik didn't get the answers as to where we are going. This is a matter of equity. It is not a matter of revenue, it is a matter of fairness. I don't suppose there is such a thing as just and fair tax laws. But I thought he might, his answers might have been, and this is not the rhetoric of a candidate fOr the nomination to the Presidency. I am not running. I don't believe any of you are. But I thinkthe question or the reply should have been that we can afford this if we would cut out SOme of the tremendous expenditures in which this Government has been engaged for a long period of time, for programs that are proved failures. This is not rhetoric, If somebody wants to take an hour, unlike the Presidential candidate wh~ said he would reduce the bureaucracy, but he would figure how to do that later. I think many would support it, We should be doing that now, instead of worrying about the alleged inability to do equity and justice in this instance here. We make up that revenue through cutting out a lot of programs which everyone knows are failures. Mrs. KEYS. Mr. Chairman. Mr. BURKE. Mrs. Keys. Mrs. KEYS. I just want to comment and thank the panel. I enjoyed so much the period of discussion between you. I did have one question of Mr. Brandon. I am very interested in the concept of developmental rights that some States you say are pursuing. I wonder if just offhand you could tell me what States are doing something about that or, if you don't have it on the tip of your tongue, if you would furnish that information. Mr BRANDON Well, I can mentioned a partial hst I know Massa-. chusetts and Maine are both considering legislation sdong these lines, Pennsylvania has a State law which will allow any locality to pass such laws, and through the property ~tax. I know `Suffolk County, Long Island, has a process on development rights, and there are a number of areas around the country that have passed these laws already and many, many more that are considering th~m. Mrs. KEYS. Thank you. Mr. BUTALA. ~ Keys, may I say in California, for example, a farmer can dedicate his land for farming use for 10 years by contract with the State, but the Internal Revenue Service refuses to agree PAGENO="0390" 376 with that as a, measure of value so it doesn't do the slightest bit of g9od. Mr. BRANDON. Just one point. Under current law a farmer could deed over rights to a charitable or conservation organization to receive a full charitable deduction on the value of those rights, and in effect get the same kind of treatment. The problem is they would have to part with those rights forever, and if the heirs do decide farming is not right for them, they won't be able to get, it back.. Mrs. ICEY8. Well it sounds very interesting to me. I would like to do some more studying on it. Thank you. Mr. BURKE. Thank you. We wish to thank the panel for their appearance. Our next witness is a Member of Congress, Hon. James F. Abdnor of South Dakota. Mr. CONABLE. Mr. Chairman, I would like to welcome our colleague. He was out of the room when his name was called before and he has had to be very patient today. We are sorry. We know he represents a very important farm area. Mr. VANIK. Mr. Chairman, I would suggest to the members of the panel who have just concluded, I would certainly appreciate, if they have any supplemental ideas, that they address them in a communica- tion to the committee. As this debate and discussion goes along,. certain facts were raised and we would certainly like to have your continued responses. Thank you. Mr. BURKE. We welcome you here to the committee and commend you for your patience. STATEMENT OP HON. ~1AMES ABDNOR, A REPRESENTATIVE IN CONGRESS PROM THE STATE OP SOUTH DAKOTA Mr. ABDNOR. Thank you. I appreciate the opportunity to be here. Mr. Chairman and distinguished members of the committee. I thank you for the opportunity to testify on the general subject of Federal estate and gift taxes. I have anxiously anticipated these hearings for quite some time. This committee, and the distinguished chairman, Mr. TJllman', have been patient in dealing with those of us who have been urging considerationof these measures. ,Tax reform has been a huge effort for this committee. We applaud your work. You have been working on tax provisions that affect huge corporations and vast enterprises. Your hearings today, however, are concerned with average citizens ih our country; the millions upon millions of individuals with small estates who have been inhibited through outdated tax provisions from leaving to their survivors the fruits of their labor. I want to speak on behalf of these people. In being their spokes- man, I do not come in any capacity as an expert who can testify as to the complexities and detiils of estate taxation. I do,' however, wish to touch on the human impact of present tax' regulations and the need for their change."Some 10,000 South Dakotans have contacted PAGENO="0391" 377 me on this matter This refiect~ui of concern by s~h a big number is largely because we are a State of farmers, ranchers, and ~ma1l busi- nessmen They are particu'arly a~ected by present tax provisions Estate tax problems of faiuily 1~arms and family businesses are unique These are closely held businesses, to be worked on, and devel- oped, and passed on from one generation to the next. On family farms, for example, 70 to 90 percent of .a farmer's holdings are tied up in fixed assets, such as livestock, which compounds the problem of paying a tax claim. A recent ILS. Department of Agriculture survey of landowners in a midwestern State turned up typical results-91 percent would not have sufficient liquid assets in their estates to cover settlement costs and death taxes if they were to die on the day interviewed. I think this is typical for family businesses and farms. And it is no less true for small town doctors and dentists and lawyers. These people have worked their entire lives to build up modest estates. Under the present estate tax structure they are often effectively prohibited from leaving to their families the results of those years of work which, for the most part, have been dedicated to perpetuating a family enter- prise as a family heritage. The trials for a surviving spouse, especially a widow, are well known. I have countless letters on file from widows who first suffer the pain of the loss of their husbands, and then must sacrifice the holdings that they both worked together to build, only because we have failed to update tax provisions that time has rendered obsolete. Estate settlement is most severe after both the husband and wife of the original estate have died. Current provisions are structured to discriminate against the children of deceased parents who wish to continue the business or farm or professional office left to them. For example, there are only half as many farms today as there were 25 years ago. Now it is true, other factors have perhaps been principal deter- minants in this development. But failure to alter existing estate tax provisions will accelerate this depopulation of rural America, and further increase the multitude of problems in that area. Some claim the family farm is but a romantic holdover from years long past. Yet it is clear that these are highly efficient units of production. It would be tragic if the structure of American agriculture was destroyed through outdated tax provisions. The same holds true for small businesses. The Federal Government spends money through long-established programs and agencies to build small businesses and assist them. Yet what we do here today will perhaps have a greater impact on small towns in America than all of these programs. For what We really are contemplating is legis- lation to protect small towns today and not find expensive ways to rebuild them in the future. We hear much about providing opportunities for young people to go into farming or business. We even have proponents determined to put the Government in the business of buying land ~o it can, in turn, be sold to young farmers ~wilhing to go into this profession. I submit, Mr. Chairman, that re~ief in the estate tax provisions would do more to encourage young people to continue the businesses and farms in rural America añd~at a fraction of the cost of these other programs. PAGENO="0392" 378 Thia committee is far more familiar than I with these tax provisions and the need for their change. I relate only the urgency which in- forms QW~ worl~ here today. May I therefore urge the ~~mmttee to consider estate tax reform independently of general tax reform? The tremendous number of sponsors of le~is1ation to alter tax provisions relating to estate settlement is clear evidthce of the nationwide interest in this legislation. Your favorable consideration will provide imme- diate relief to these people who have been neglected for so long. Mr. Chairman, I would also like to submit to your committee state- ments and letters that I have received from South Dakotans who would li1~e to go on record for this legislation, if I might. Mr. BTJRLESON [presiding]. Without objection, they will be included in the record. {Material submitted for the record by South Dakotans begins at p. 1723.] Mr. SCUNEEBELI. Mr. Chairman. Mr. BURLESON. Mr. Schneebeli. Mr. SXHNEEBELI. Thank you, Mr. Chairman. Since Representative Abdnor represents the heartland of America, I am sure that he has been on the firing line with respect to this issue with many of his constituents. I might ask you, do your views apply to small business people? Have you been hearing from them, as well as farmers? Mr. ABDNOR. Yes; many of the small businesses in these little towns, where they have put their entire income and wealth into the inventory of their businesses, that is right. Mr. SOITNEEBELI. I am aware that the Farm Bureau and farm organi- zations have been promoting and reminding their members that this subject is about to come up, and I didn't know if small business groups have gotten together or have been alerted to this subject; apparently they have. Mr. ABDNOR. I have been talking this well over a year. Qccasionally you get carried away and you think you are talking only to farmers and you start talking about this in terms of farms and I soon was in- formed in no uncertain words that there are many small businesses who need this as well as farms. Mr. SOENEEnELI. Well, I subscribe to your thinking and thank you very much for coming. Mr. ABDNOR. Thank you. Mr. BURLESON, Are there other questions? Mr. PIcKra~. Mr. Chairman. Mr. BURLESON. Mr. Pickle. Mr. PTCKLE. I just want to say to our colleague we appreciate his testimony, particularly when he says this one act might do more to encourage young people to stay in business or on a farm or ranch. At the time when the trend is going the other way, it could be very im- portant to the country. I think he makes a good point on that. I want to compliment him for his statement. Mr. ABDNOR. Well, thank you, Mr. Pickle. I would just like to say that this is true, these are young men on the farm of their fathers, trained to know the business. It is a very tech- nical, skilled business now. You just can't put anyone on the farm, without training and experience. And here we have the cream of the crop who want to continue, but right now we are driving them off the farm because of the present law. PAGENO="0393" 379 Mr. PICKLE. I think you have maclb a very good point. Mr. Bum~EsoN. Are there any other questione? Mr. Mikva. Mr. MIRTh. I just want to thank your colleague for being here today. I am impressed by his remarks and agree with you, Mr. Chairman, that we must keep very close to this situation. Mr~ AEDNOR. Thank you very much. I thank you for this opportunity. Mr. CONABLE. Mr. Chairman, I think we all want to associate our- selves with the remarks of our friend. Mr. B-URLESON. Mr. Abdnor, we appreciate your remarks and your coming before the committee. Thank you very much. Mr. ARDNOR. Thank you. Mr. BtJRLESON. The next witness is our colleague, Mr. Baldus. Mr. Baldus, we are happy to have you before the committee, and you may proceed. STATEMENT OP ~tON. ALVIN BALDUS, A REPRESENTATIVE IN CONGRESS PROM THE STATE OP WISCONSIN Mr. BALDUS. Thank you for this invitation. Mr. Chairman, members of the committee, I can't tell you how pleased I was to learn that you had scheduled hearings on estate tax legislation. Reform is not only needed, it is being urgently requested by people across the Nation. I am hopeful that the testimony which you receive will result iii legislation to reform our archaic and punitive estate tax laws. The economic Mckbone of my rural district is the small, family en- terprise, be it a farm or a small business. These enterprises are gen- erally too small to be able to absorb the impact of estate taxes. All too often the family is forced to either sell the enterprise to pay the taxes or choose the route of merger and consolidation to ~vo4d taxes. And merger and consolidation only result in the deterioration of the quality of life in rural America. The ~urrOnt status of Our estate tax laws is a topic of general con- cern throughout my district. Since taking office, I have found com- plaints about the estate ta~ to be one of the' more predominant issues mentioned to me by my constituents. I have been pursuing a series of open forums in the communities of my district, and at each one the estate tax iS cited as a major problem. As recently as 3 days ago, I con- ducted a public forum in Ean `Claire, Wis., specifially on the question of estate taxes. The sentiment of those attending was unanimously in support of changes in estate tax laws. As a resu]t `of the impact of estate taxes throughout Wisconsin and the Nation~ Senator Gaylord Nelson, Representative David Obey, and I, have joined in introducing the "Small Business Estate and Gift Tax Reform Act," H.R. i1484,'~whi~h is pending before this committee. This bill, originally introduced in the Senate by Senator Nelson, chairman of the Senate Small Business Committee, is based on 10 days of hearings before his committee in Washington followed by 4 days of field hearings in Minneapolis, Miun.'; Eugene, Oreg.; and Milwaukee and La Crosse,'Wis. I had the privilege of cochairing the hearings `in Milwaukee and in La Crosse, which is in my district. PAGENO="0394" 380 Our bill has the following features: First, it would double the size of the estate ta~ exemption, from $60,000 to $120,000 in three $20,000 stages-in 1976, 1978 and 1980. Second, the lifetime gift tax exclusion presently at $30,000 would rise to $60,000 immediately, in 1976. Third, in order to give a faimer or businessman additional fiexibil- ity in transferring, productive property, the bill would permit a com- bined use of these two provisions-partially in 1976 and fully in 1980. Fourth, in recognition of the contributions of wives to agricultural and other family enterprises, the bill would allow transfer of the first $240,000 or business and other property to a surviving spouse free of tax at death. Fifth, the option to defer estate tax payments under section 6166 would become more accessible and less expensive by permitting sub- stitution of a lien on the assets of the business for the personal liability of the executor and expanding the definition of closely held business to 15 partners or shareholders. Sixth, stock redemption possibilities under section 303 of the Inter- nal Revenue Code would be expanded to 10 years, and the penalty against participation in more than one business would be removed. Seventh, a farmer or other small entrepreneur would be permitted to reduce the value of his property for estate tax purposes by restricting its future uses. In the interest of brevity, I have refrained from engaging in a lengthy documentation of the history of the estate and gift tax exemp- tions and the negative impacts which they have recently come to create. Much of this is being covered in the testimony of others before the committee and would only be repetitive. With the consent of the committee, however, I would like to insert in the record the statement of Senator Nelson when he introduced this bill in the Senate. I commend it to the members of the committee as a concise and persuasive documentation of the need for new legislation. Mr. BURLESON. Without objection, the statement will be introduced into the record. Mr. BALDITS. Thank you, Mr. Chairman. [See p. 436 for the introduction of the bill in the Senate by Senator Nelson.] Eighth, the Treasury Department would be instructed to recom- mend to the Congress within a year additional legislative and ad- ministrative estate and gift measure~ which could further encourage the continuity of small, family and locally controlled farms and businesses. I am also a cosponsor of the Burleson bill, which seems to have the most support of all the measures before this committee. While the Burl eson bill is roughly similar to some of the proposals in our bill, I think that we ~o one sten further by granting special recognition to the role of the wife in a small enterprise. Tn the majority of cases, the wife takes care of the normal house- hold chores and then can be found working side-by-side with her hus- band in the field and barn or behind the counter. It is not at all un- usual for the wife also to have full responsibility for the bookkeeping for the family enterprises. Yet, more often than not, when the hus- band dies. she is treated almost ~s ~n outsider. or worse yet, she is penalized by taxes because of the husband's death. PAGENO="0395" 381 Our bill acknowledges this by allowing a surviving spouse an ex- emption of $240~0D0 plus 50 percent of the remainder of the estate. To those who would consider this to be too large of an exemption, I would like to point out that when the surviving spouse passes on, the estate will be subject to the normal rate of taxation. Mr. BALDUS. In conclusion, I am not uncompromisingly wedded to the levels of the exemptions which are contained in my bill. The com- mittee will be in a better position to determine what the acceptable levels are. I would, however, like to urge upon the committee my pro- visions for special recognition of surviving spouses. The. surviving spouse is in reality, if not on paper, a co-owner of the small enterprise and should not be cast aside at the death of the spouse. I have one final thought: Estate tax revision has come to be identi- fled as a measure to aid farmers. The President himself offered his proposals only in the context of farmers. But legislation such as my own would not impact only on rural areas. It would also provide needed relief for the thousands of small business enterprises and stores in the cities of our great Nation. This is not legislation for rural con- stituencies; it is legislation for all of us. Mr. BUBLESON. Mr. Baldus, thank you for a very impressive state- ment. I particularly respond to your more liberal treatment of the surviving spouse in this legislation. I don't know whether we can be that generous to them, but I would favor it. You reach for that which you think is possible. Are there questions for our colleague, Mr. Balcius? Mr. STEIGER. Mr. Chairman. Mr. BtTRLESON. Mr. Steiger. Mr. STErnER. I thank you, Mr. Chairmaii. I first of all want to welcome our colleague from Wisconsin's Third District to the committee. I am intrigued by the approach he offers. Do you mean any spOuse, regardless of whether the spouse did, in f act, contribute to the enterprise, should receive this kind of treatment under the estate law? Mr. BALDiJS. There is only opportunity for two, of course. I think I understand your question, however, and that may refer to the length of time of the marriage, and that sort of thing. You may put your finger on an inequity, but to correct that inequity would get pretty complicated and I think the present e~emption recognizes spouse with- out references to the length of time of marriage, or without a specific contribution to building the estate. Mr. STEIGER. Thank you. Mr. BTJRLESON. Mr. Waggonner, do you have anything to add? Mr. WAGGONNER. Mr. Chairman, I just want to welcome our col- league here and thank him for his statement, not to reassure him, but you do have good intentions, Mr. Baldus. Mr. B1JELESON. Mr. Pickle. Mr. PICKLE. Mr. Chairman, I join our colleague. At the beginning of your statement, Mr. Baldus, you stated that one group had recom- mended the doubling of the exemption. What group had made that recommendation, and what was the document you referred to at the beginning of your testimony? Was there a report from some other group? Mr. BALDUS. I think it is a generally held opinion that the law that was passed had as an intent at that time not to touch most of the people, that would touch rather large estates. But, because of both the growing of the value of even small farms and businesses, now it is getting to PAGENO="0396" 382 where it touches a high percentage of those estates and affects them. Mr. Pici~ti~. I thought you were reading a specific recommendation from some group or some association. I was wondering if it was from the other body or some Other national organization? Who was making the recommendation? Do you recall? Mr. BALDUS. I am not familh~r with which part of the testimony you are referring to. Mr. PIci~r4E. Well, I don't have a copy either. But I can get it from the testimony, so that will be all right. Mr. BALDUS. It may be that you are referring to the fact that Sen- ator Nelson, in the conduct of Small Business Committee hearings across the Nation, and specifically in Wisconsin. Mr. Picwts. That may have been. Mr. BALDUS. Found these recommendations, as a result of consid- erable time and effort on his part and his staff in putting these rec- ommendations together. Mr. PIc~LL All right. Thank you, Mr. Chairman. Mr. BURVESON. Mr. Baldus, thank you very much for coming before the members of the committee. Mr. BALDtTS. Thank you. Mr. BuRL1~soN. We now have a coordinated panel consisting of Mr. James D. MclCevitt, Washington council, National Federation of In- dependent Business; Mr. Milton D. Stewart, president, National Small Business Association; Edward H. Pendergast, Jr., Council of Small Independent Business Associations. These three gentlemen represent a number of small business organi- ~ations. Gentlemen, we welcome you before the committee. Mr. McKevitt, will you lead off? A PMIEL C0NSISTIN~f or JAMES D. MoKEVITT, WASHINGTON COUN. S~L, 1~TATIONAL PEDflATIO)T O~ IN ErENn1~NT BUSINESS; MIII- TON D. STEWART, PRESIDENT, NATIONAL SMALL BUSINESS ASSOCIATION; EDWARD H. PENDERGAST~ JR., COUNCIL OP SMALL INDEPENDENT BUSINESS ASSOCIATIONS Mr. MoKEvn~r. Thank you, Mr. Chairman. I, in the interest of time, will just summarize my remarks. Having formerly served in the 92d Congress and watching what you Gentlemen go through here, I am glad I served on the Judiciary Committee. I thought that was long and drawn out. I commiserate with the hours you are putting in. As I said in the interest of time I will summarize my remarks. Mr. I3URLESON. Your full statement will be printed in full in the record. Mr. MCKEvITT. Thank you, Mr. Chairman. I stated I served on the Judiciary Committee. I also served on the House Committee on Small Business and I addressed myself to these members of or~ranizations who came before us on a number of occasions, and the `biggest im- pression T had was that they weren't organized. Well, in the last 6 months they have become organized. There are now eight major groups which are organized together as sort of an ad `hoc group called COSIBA, the Council of Small Independent Business Associations. This association is made un of the National Business `League, which has 5,000 members; the Independent Business Association of Wiscon- sin, of 200 members; the Small Business Investment Companies has PAGENO="0397" 383 300 f1~'n~s ; Smaller Miu~a~tur~r~ Cqui~i1 ~ Pittsburgh has 600 members, repre~x~t~ 1S,000 to 2~000 employees ; Counail of Smaller Enterprises of Cleveland, COSE 860 members Small Business As- sociation of New England has 1,~00 members, kational Small Busi ness Association has 40,0000 members, National Business Le~gue has 5,000 members, and National Federation of Independent thisiness has 440,000 members. I think the significance of that, Mr. Chairman, is the fact that this represents all, or sigmflcantly all, of the small nidepeudent business groups across the eo~intry who have met now extensively over the last 6 months for one prime purpose~-~--to come up with a tax proposal for title I through III, which we are just in the process of drafting in final completion now dealing with business independence, coutinu ation, and growth, tax simplification and tax incentives. In keeping with the concept of the testimony, we would like to limit our testi~ mony today to the subject of this hearing, which is one of the particu- lar interests of our tax legislation which deals with estate and gift tax. In presenting this bill, we would like to do so at a subsequent time before this committee. We would like to testify on that particular point today. With me are two gentlemen; one, Mr. Ed Pendergast, who is a practicing CPA and a førmer president of the Small Thisi- ness Association of New England, will testify as to the details of our suggestion and thoughts so far a~ estate and gift tax is con~enied and how it can benefit the independent business community which, let's face it, makes up 97 percent of the firms in the country today, and 45 percent of the gross national product. But prefacing his remarks i~ Mr. Milton Stewart, who is president of the National Small Business Asso~iatjon, I would like to introduce him to you at this time. [The prepared statement follows:] STArEMENT or JAiius D. "Mxxn" Mo~nvxrr, WASIIINOTON COrwSEL, ~ATION41~ F~~iox or i~mrr~' Mr. Chairman, Members of the Committee, I am Mike MeKevitt, Washington Counsel to the National Federation of Independent Business ~N~IE), It is a distinc~t honor for me to appear here today to brief you on some recent inaportatit developments within the small bi~isiness cQm~unity. When I served in the Hou~~ ~nd tn partieula~, as a member of the I~ouse Small Business Committee, I became very concerned about the fragmented effort made by this important sector and asked many times why the natioh 5 small business associations could not agree upon a common position and the~i take it forcefully before the Congress As it turned out there were many reasons for this but J am delighte4 to be able to tell you that this Important sector of the American economy seems to be on Its way towards developing a united voice on the serious Issues thateonfront It. During 1975 eight small and independent business associations representing over half a million American firms and millions of American workers came together to d1s~uss effective small business tax reforip. These organizations are truly representative of the U.S. small business community and include: Mcnibers Independent Business Association o~ Wisconsin 200 National Association of Small Business Investment Companies 350 Smaller Manu~acturers Co~ncii of PittsburgL.~.L~.. (300 Council of Smaller Enterprises o~ Cleveland ~1&-~25,00Q employees)._... 860 Smaller Business Association of ~.iew Ez~g1and (4t~,00Q einployees)..__.._ 1, 2Q0 National Small Business Association (500,000 empioy~es) 40, 000 National Federation of Independent Business (3,845,601 émployeès)___. 4~O, 000 PAGENO="0398" 384 Over the last six months all of these groups have worked closely together to develop a small business tax refc~rm package that would insure the continued independence of tI~e small business community, provide incentives for its future growth and simj~lify the heavy administrative and paperwork burden it faces in the area of taxes. That package is now in its final draft form and we intend to present it to thiS Committee, the Congressional leadership and the Adminis- tration in the very near future. The first section of our tax package deals with estate and gift taxes-changes in the Internal Revenue Code that we believe are essential for continued small business independence. Ed Pendergast of Pendergast, Creelman, and Hill of Boston, Massachusetts, a former President of the Smaller Business Association of New England (SBANE), played a major role in the structuring of this sec- tion and is here with me to testify about its Importance to small business. Also with me today is Milton Stewart, the President of the National Small Business Association who would like to answer briefly a question posed by Congressman Conable about the risks related to operating a small, independent business. STATEMENT OP MILTON D. STEWART Mr. STEWART. Thank you, Mr. McKevitt. Gentlemen, in the interests of conserving your time, let me just say quickly, first, I am here to underscore the unity you will find from now on in the small business community on the subject of taxes. Second, we hope you will, without failure, take speedy action on what appears to be a bipartisan agreement that estate taxes ought to be dealt with for small business, small farmers, and independent profes- signals are overdue for some reform in this area. Third, as "Mike" has indicated, we hope that you will not limit your consideration in this session to just the subject of today and that you will deal with other small business tax reform needs. On this, I have given you a chart which we brought up to date showing large- scale mergers in America. This goes back to a question my fellow New Yorker, the Honorable Mr. Conable, asked when I was here once before: Did I think that this was becoming a society that looked to avoid risk in the business community. I think you are right on target in considering estate and gift tax from the standpoint of stimulating business. The reason this chart is relevant, if you take a look at it, the situation is not quite as great as it looked. But we have had a slack-off of major mergers as suggested against the rest of the economy, largely because of the recession and of the low points in the stock market. If you follow the papers, Mobil is now acquiring Marr Co. and GE is talking about acquiring Utah International. To those of us who are concerned about the relative share of the economy that small business has the opportunity to oc- cupy, these are profoundly important figures. The Dow broke for a moment the thousand number last week. That means that the cur- rency of major corporations now gets to be enough so they can start buying again, and we are very likely at the beginning of a new merger trend. If you do the estate and gift tax area right, particularly estate tax, it will help to keep the independent sector independent, help to encourage people to take risk, keep on taking risk and have their children do the same. I think really that is about the sum and substance of what I have to say, gentlemen, except that we all stand together, and Mr. Pender- gast is perfectly competent to speak for all of us with respect to the details of our proposal. Thank you. [The prepared statement follows:] PAGENO="0399" 385 ATfi~JE~T O~3' MILToN D. SP15WAR~, PRusIDENT, NATXO~AL. SMALL Busn~nss AssocIATIoN Mr. Chairman and members of the committee, my role here Is to make five quick points for you. First, in organizational terms, to urge you to respond to the significance of the unprecedented fact that eight small business groups have now come to you with the first, element of l~ jointly-supported small business tax program. We hope you will read that as a sign of the sense of urgency we have about the tax needs of mUUons of American small enterprises. Second, to urge upon you speedy action to take advantage of what appears to be a bipartisan view that action on estate taxes for small businessmen, small farmers and independent professionals is long past due. rihird, to urge you not to limit this Session's concern about the independent sector to what happens to the assets of its principals after they die. It is just as vital that you provide the Congress with leadership on some measures to enhance the prospects that the living businesses keep on living and start growing again. Fourth, I would like to urge specifically that you keep one eye on the stock market as you think about your priorities for the next few months. For the past several years the recession and the low state of the market has produced an apparent pause in the economy's aggregate manufacturing asset concentration. In other words, troubled as it has been, for the past several years the rest of the economy has not been outgrown by the largest 100 or 200 companIes in the country, Our whole economic history would indicate that a new merger move- ment is about to begin. The more attractive you make small enterprise in this Session of Congress, the . more you will take the tax-induced steam out of a re- born merger movement. While I do not want to overstate how much can be achieved by better small business tax policies-policies which put a premium on independence of enterprise rather than size-we have every good reason in hoping you can make a contribution here. Fifth, I cannot close without saying to you frankly that across-the-board small business tax reform is your most past due business. Five years of work went into the old Bible-Evins bill without significant positive result. It is almost three years to the day since I appeared before this Committee and pleaded for a long- term, all-inclusive Tax Magna Carta for Small Business. We. have yet to see the first permanent step toward it; you did take a meaningful step last year in the emergency tax relief measure. We hope that swift small business estate tax activities will be the beginlnng and not the end of small business tax reform in this session. CHANGE IN CONCENTRATION OF CORPORATE MANUFACTURING ASSETS COMPARED WETH MOST ACTIVE MERGER PEI3IODS, 1925 THROUGH 1968 PErCEST OF" - `~ `-`~` __________ __________ ___________ -`-~ ,--,i-.J -~ ~,. ~ - I ~ - J ~- "i; ~-:i ~ ~ 1" El Nest setive morger periods Acqsircd Aes.1s oxcoed 05% of tetal Ctrporato Menufecturing ISlets. ~ ~ I.~sT ~ -~----~ ~sT,** / -~ IV - ,I~e ~ - ~~0u ~ - 30- = -~ 1925 1930 1935 1940 Source: Bureau ol Economics federal Trade Commissiun 1945 1050 1955 1960 1965 1970 PAGENO="0400" 386 SHARE OF ASSETS OF 200 LARGEST MANUFACTURING CORPORATIONS OF 1968 AND ACCUMULATIVE ~OMPONENTS OF GROWTH; 1947, 1960 AND 1988 ~ Share of assets 1960 and 1968 less merger 1~1 Industry growth effect * Merger component of growth, L_J and Industry components of growth 1968 Source: Bureau of Ecenemfua. FH.ual Trade Cen.mleulon, The changeover of reporting to exclude foreign assets begins to appear in 1973. In other words, approximately 3 percent can be added to 1973 and 1974 to make them consistent. This means there has been no noticeable drop in aggregate con- centration. There has also been no significant upward movement. Mr. BtTRLESON. Thank you very much Mr. Stewart. Mr. PENDERGAST. Mr. Chairman, my name is Ed Pendergast. Mr. BURLESON. Oh, I am sorry, I had you confused. STATEMENT OP EDWARD H. PENDERGAST Mr. PENDERGAST. That is all right. The name tag may be wrong. Thank you very much for the opportunity to appear before you today. Please enter my statements in ~he record I don't want to take too much of your time either, Mr. Chairman, but I think the 500,000 small businesses we represent here do deserve at least 10 minutes of your time. I would like to spend about 5 minutes outlining what I think is a case that emphasizes the problem small business has in the estate tax area and then 5 more minutes in telling you what we have to make for proposals to you. There is a Mr. Adams who lived in New England where I come from. In 1951 he incorporated. He received 62 percent, his family 13 percent and his partner acquired 25 percent. His investment was $25,000. His company prospered and his son and daughter came in the business. They had great plans for growth in 1973. Mr. Adams died unexpectedly in 1973. The accountants and lawyers came in, tried to make a valuation on his share of the corporation. They valued it at half a million dollars. Unfortunately, the company was illiquid; they could not have a section 303 redemption because there were no assets to pay the taxes. A section 6166 extension of payments time was very expensive because of the interest rate and is limited as to the source that it can be used for. Finally, the two children raised the money through borrowings to pay the tax. The business was at a standstill and remained that way almost completely for 2 years in dealing with the problems of the estate and trying to make sure that th~ confirmation of their valuation of the business, once the IRS came in, would hold. 1960 1 ____________________________________________________________ PEtCENTAGES -. ARE OF TOTAL 1941 ` ~ "~~:`:; ,,.~: `: *`~ *`.:~:: 42.4% ~t5r00~'t55 PAGENO="0401" 387 In 1975, the IRS came in and said the business was worth $2 million. This would have increased the tax $22~,000, There was no cash avail- able to pay any additional tax. The son and daughter panicked, tried to sell ffie business and found, of course, they could get nothing like that for the business. In fact, they found that any offers they got involved the loss of 75 jobs and relocation of the remaining employees Finally there was a compromise value made. The IRS accepted a value of a million dollars, still an increase in tax of $47,000. The result was that the company and the son and daughter are now borrowed to the hilt, the business almost went under, 75 jobs were almost lost and the one~s~ot estate and gift tax imperiled the annual collection of the corporate income tax in succeeding years. This is a trUe case, changed very slightly to protect the integrity of the people involved. We know that you can't solve this family's problem, but we think you can help. We think, in the first place, that the $60,000 exemption which was granted initially in 1942 is not high enough. Simple inflation tells you it is now $180~000, and that is using the figures of the Joint Eco- nomic Committee. We suggest you modify the rate structure for estates under a million dollars, giving them some relief there The details, as I say, are in. my statement and I am not going to go into them in detail unless you re- quest me to do so. A third step we would like to liberalize is the eligibility requirements of section 308 extensions and extension of time on 6166.' I think the most important area is in valuation of closely held busi- nesses. We would like not to approach it as a capital gains tax at date of death. We would like to allow the beneficiaries to have the option to eakø the descendant's basis, so that when they finally disposed of the business they would pay a capital gains tax on the differentiation be- ~ween what the descendant had paid for the business and what the receipts were from the sale of the business. This times the coincidence of the tax with the resources able to pay the tax. We think these steps would lead to a saving of many family busi- nesses which will pay future taxes It will save iobs in small family held businesses to pay ongoing taxes, and the one-shot estate tax will defer to the ongoing, stable, revenue-producing enterprise. Thank you, Mr. Chairman. [The prepared statement follows :J STATEMENT OF EDWARD H. PENDEROAST, JR., IN BEHALF OF COUNCIL OF Si4ALL INPEPENDENT BUSINESS ASSOCIATIONS (COSIBA) Mr. Chairman, thank you for this opportunity to testify before the Committee on Ways and Means of the iJñlted States House of Representatives for these bearings on estate and gift taxes. I :~i~ Edward H. Pendergast, Jr.,. Certified Public Accountant and partner In the firm of Pendergast, Creelman & Hill of Boston, Massachusets. I have served as Past President of the Smaller Business Association of New England, am Presi- dent-Elect of the Massachusetts Society of Certified Public AccOuntants and serve as a member of hte Internal Revenue Service's Small Business Advisory Committee. Today I reuresent COSIBA, the Oouncil of Small, Independent Business Assoel. ations. COSTBA consists of the major small business assodations as follows: Council of Smaller Enterprises (Ohio) Independent Business Association of Wisconsin National Association of Small Business Investment Companies Nationel Business LeAgne~ 68-872-76----26 PAGENO="0402" 388 * National Federation of Independent Business National Small Business Association l~ma1ler Business Association of New England Smaller Manufacturers Council (Pensylvania) COSIBA has a total membership of nearly 500,000 busIness units and, through seminars, educational institutions, the Small Business Administration and others is in contact with the bulk of the small business community. En other words, we truly represent the voice, of small business. This is the first time that small busi- ness has been able to speak with one powerful voice. As such, we urge you to understand that the problems of small business are not always the same as any other sector of the community. Our puropse herO is not to ask for preferential treatment, but to have you recognize our unique problems and the desirability of nurturing the small business community as both a mainstay 0± our economy and the major hope for future economic growth and development, Some of our prob- lems are intensified by the operation of the estate and gift tax laws. The estate and gift tax sections of the Internal Revenue Code have not been overhauled in over 20 years. Inflation and other circumstances have eroded many of the mitigating sections of the Code since then. We are concerned with a number of issues. 1. Amount of exemption from tax (Sections 2052 and 2521) 2. Rates of tax (Sections 2001 and 2502) 8. Stock redemptions to pay death taxes (Section 803) ` S 4. Transfer of Business Interests at death (Proposed new Section 2057) Before we discuss the specifics, I would like tO cite an example. The following is an actual case with circumstances changed sufficiently to protect anonymity of the taxpayers. It will give you some example of the real problems confronting a small business. It will be obvious how the preseiit estate aud gift tax laws have intensified a very difficult set of circumstances. CASE STUDY Mr. A established X Company some years ago. Business prospered and Mr. A took in a partner. Mr. B. when X Company was incorporated. Mr. A received 62% ~f the shares of X Corp., Mr. B received 25% and members of Mr. A's family received the remaining 13% of the shares. Mr. A's investment was $25,000. The Company happens to be in a service business but `the same circumstances apply to companies in wholesale, manufacturing and retaiL Because of his skill and a. good product, the company's growth has been rapicL Since X Corp. canot raise equity capital and is limited as to the amount X Corp. can borrow, growth must be financed through retention of earnings. In 1973, X Corp's assets were deployed toward a plan for growth. No excess resources are available. As Mr. A said, "iou' either grow or go". Mi~. A's~ two children `S and P have become active in the business and" are . owners of the remaining 13% of stock referred to above. Mr. B is sickly, but still actively contributing to the business. Unexpectedly, Mr. A dies, partly as a result of overwork to implement the expansion plan. Lawyers and accountants arrive on the scene. The outline of bjs estate is attached as Exhibit A. Mr. A's shares in X Corp. are valued at $27,000. The estate taxes and administration of the estate plus liabilities total $125,919. As Is evident there is a severe liquidity problem. Mr. A's estate can only raise $58,600. Where will the rest come from? Some can be raised through the operation of Section 303 by effecting a partial redemption of the stock. Some can he deferred through an extension of `time using Section 61~6, but thiscarries with it a substantial interest rate. The beneficiaries of the estate can try to raise~cash. Finally the money is raised. Everything in sight is pledged. All parties are nervous because the estate is subject to an audit. In 1974, the 25% shareholder dies. His estate's problems are as horrendous as Mr. A's, hut will not be detailed here. The business is virtually at a standstill. Fortunately, the son S proves to he an able administrator, but the problems of the estate have been a major distraction. As part of the growth program X Corp. isoffered chances to acquire two small businesses at a good price. Because of the valuation question pending before the Internal Revenue Service and that of Mr. B, the corporation is advised to wait for the audit of the estate to deterthine the value of the corporation for estate tax purposes. Finally, in 19Th, the Internal Rèvenué Service ai'rives and proposes to value Mr. A's shares at ~2.000,000. This would increase the federal estate tax by $221,000: In a panic, the shareholders attempt to sell out. They find that they PAGENO="0403" ~389 ar~ luék~i~ they. c ñld'~eo~i'V~ half of the Int~rnal'Reve~iue Servic&s valuation. Further, all offers involve consolidating X Corp's business into a larger busifless with a resulting loss of 75 jobs. The remaining jobs would require ~`elocation. After muck negotiation, the valuation of Mr. A's shares is set at $1,000,000. Even at that, the additional federal estate tax is over $47,000! Estate tax considerations have paralyzed the business for almost two years. The $60,000 exemption and the high rates of tax have almost caused a business and 75 jobs to disappear. X Corp and A's beneficiaries have been forced to borrow in excess of the limits dictated by prudence. The Company is not able to redeem the shares of the 25% shareholder. No one knows how Mr. B's estate can meet its death tax requirement. The 25% mInority interest is of little value on the market, but will be given some reasonably substantial value for death taxes. Senator Nelson of Wisconsin, the Chairman of the Secret Senate Committee on Small Business says, "The (federal estate) tax literally is forcing the small operator to sell out or to merge with the giant corporation. It has become in effect, a cancer in American Society, eating away at the vitals of local economies and sapping the energies of economic growth". In this case, the cancer was very nearly terminal. The specifics of our proposals to alleviate some of this burden follows. The actual language of our proposed legislation is included as Exhibits B through E. Amount of evem.ption At present, the first $60,000 of assets are exempt from taxation in an estate. The last time any change was made in this exemption was in 1942. According to the Wall Street Journal, the Inflation corrected equivalent Is $210,000. Accord~ lug to the Joint Economic Committee, the percentage inflation from 1942 to 1975 was 289.3%. Today's equivalent of 1942's $60,000 under this formula is $173,600. Thus the estate of the man who purchased a home In 1940 for $20,000 that Is now worth $60,000, could be at the threshold of estate taxation. This is absurd. He will surely have some other assets which will be subject to tax. You will, I am sure, hear Senator Nelson speak to the provisions of his bill S2819 which discusses a $120,000 estate tax exemption and a $60,000 gift tax exemption, allowing the estate to use any unused portion of the $60,000 gift tax exemption in addition to the $120,000 exemption. `Similar proposals are embodied in HR. 11484 introduced by Mr. Baldus of Wisconsin anc~ HR. 11496 iptroduced by Mr. Obey of Wisconsin. Close to these bills is H.R. 1793 introduced by Mr. Burleson of Texas. Mr. Burleson's Bill suggests an Increase of the estate tax exemption to $200,000. In light of sil of the above, we suggest that $150,000 is a reasonable figure to exempt from federal estate taxation. As an integral part of that, we recozrl- mend the estate tax's relation to the gift tax be continued. This would increase the specific exemption to $90,000 and the annual exclusion `to $9,000 per donee. Rates of tacit In the same manner that inflation has eroded the exemptions, the graduated structure of the tax is also too burdensome. Our proposal is as follows: Tax rate (percent't Taxable estate ` Present Proposed Oto $5,000 3 5 $5,000 to $10,000 7 5 ~10000to$20000 11 5 $20,000 to $30 P00 14 5 $30,000 to $40,000,_ 18 5 $40,000 to $50,000 22 5 $50,000 to $50,000 25 10 $00,000 to $100,000 28 10 ~100,C00 to $150,000 30 15 $150,000 to $200,000 - 3~3 20 $200,000 to P250,000 - 30 25 $250,000 to 51151,000 32 25 $4001000 to $500,000 - 32 30 $500 000 to 5000,000 35 30 $000,000 to P750,000 ` 35 35 V50,000 to $1,000,000 37 35 Ovec $1,000,000 (1) (1) I No change from present rates. PAGENO="0404" 390 (lift tax are rates presently 75% of estate taxes. We propose this ratio be maintained. $took redemptlon8 to pay death taa'es Under present law continued in Section 303 of the Internal Revenue Code, some stock may be redeemed to pay death taxes if the shares of that stock are a major asset of the estate. The distribution is not treated as a dividend and the stepped-up basis results in no capital gains tax. This Is an excellent opportunity to save ~ closely held business from extinction through merger ~r liquidation `to pay estate taxes. The problem is that the limitations are too onerous. The stock must represent more than 35% of the gross estate or more than 50% of the taxable estate of the decedent. We suggest these percentages be liberalized to more than 20% of the value of the gross estate or more than 40% of the tax- able estate of the decedent. Transfer of business interest at death The average small business uses all Its liquid resources to buy equipment, pay payroll and taxes. When a major shareholder employee dies, there Is frequently not enough cash available to effectuate a 303 redemption. Creditors are less anxious to extend credit and customers are wary of new management. What do you do in a case like this? Probably sell or liquidate. To relieve this Impossible situation, we propose that the estate be allowed an optional basis for eligible stock equal to the decedent's basis. Thus, the beneficiaries would receive the stock at the old basis and the death taxes would be paid on that basis. When the business was sold or liquidated, the beneficiaries would pay a capital gains tax calculated on `the decedent's basis. We propose eligibility requirement be the same as Section 303 requirements. The business could survive, death taxes would not strangle and ultimately the federal government would get its taxes at the time money is available to pay the taxes. CONCLUSION Every year small businesses are strangled by the onerous burdens of death taxes. In some cases, the beneficiaries have to pledge or sell their own assets to retain the family business. In other cases, the businesses have to be sold at dis- tressed prices. This should not be the result of years of hard work, nor should our taxlaws be structured to crush the small business. Our economy suffers. The famed American technology superiority is eroded, and we end up encouraging people to take the "safe" route and work for some Impersonal monolithic giant. In the forest, new trees must spring up from acorns or the forest will soon be destroyed. So, too, In our economy, we must encourage the development of new business. EXHIBIT A Case study of the liquidity needs of the estate of Mr. A. Total estate assets-Liquid: Life insurance $50, 000 Cash and securities 5, 600 Total 55,600 To be liquidated: Car 3, 000 Total , 58, 600 Not liquidated: Business 527, 000 Home 55, 000 Total 582, 000 Total estate assets MO, 600 Gross estate: Total estate assets 640, 600 PAGENO="0405" Liabilities Notes pr~t1 Mortgages Last expe~~ Other 391 ~t~4L)It~ 3, 000 2,000 ~____ 3,000 5,000 Total 18, 000 Gross estate___~ _62~,600 Administration costs: Gross estate 627, 600 Administration cost at 5% ~1, 380 Adjusted gross estate: Gross estate .~ 627, 600 Deduction~s: Administration cost - - 31,380 Adjii~ted grOss estate ~__ 596, 220 Federal estate tax (FJD.T.) adjusted gross estate with marital deduc- tion 58~ 578 inneritance tax 22, 961 naoiuues 13, 000 31, 380 58, 578 22, 961 112,919 125, 919 58, 600 70, 319 availability - Total Liquidity ~ LlqtIidlt~~ Liquidity 4IAlioit State Liquidity needs: Gross `~ Estate clearance costs: Administration F.E.T S.I.T EXHIBIT B PROPOSED CHANGE IN INTERNAL REVENUE CODE AD~1U5TMENT OP ESTATE TAX RATES (a) Section 2052 (relatIng to the exemption from the estate tax) Is amended by striking "60,000" and by substituting in lieu thereof "$180,000". (b) $ection 2001 (relating to the rate of estate tax) IS amended by striking the rate schedule contained therein and by inserting In lieu thereof the follow- ing new rate schedule: "If the taxable estate Is: The tax shall be: Not over $50,000 5% of the taxable estate. Over $50,000 bu tnot over $100,000 $2,500 plus 10% of the excess over $50,000. Over $100,000 but not over $150,000__~_ $7,500 plus 15% of the excess over $100,000.. Over $150,000 but not over $200,000____ $15,000 plus 20% of the excess over $150,000. Over $200,000 but not o~ter 400~000.___ $25,000 plus 25% Of the excess over $200000. Over $400,000 but not over $600,000____ $75,000 plus 80% of the excess over $400,000. Over $600,000 $185,000 plus 859~, of the excess over $600,000. PAGENO="0406" 392 EXHIBIT C PROPOSED CHANGE IN INTERNAL REVENUE CODE (a) Subsection 2503(b) (relating to exclusions from gifts) is amended by striking "$3,000" and by substituting in lieu thereof "$9,000". (b) Subsection 2521 (relating to the specific exemptiun from gift tax) ia amended by striking "$30,000" and by substituting in lieu thereof "$90,000". (c) Subsection 2502 (a) (relating to the rate of gift tax) us amended by strik- ing the rate schedule contained therein and by sulistituting in lieu thereof the following: "Rate Schedule" "The rate of tax imposed by Section 2501 shall be 75% of the rate imposed by Sectuon 2001". ExHIBIT D PROPOSED CHANGE IN INTERNAL REVENUE CODE REDEMPTIONS OF BUSINESS INTERESTS TO PAY DEATH TAXES (a) Subparagraphs (A) (1) and (ii) of Subsection 303(b) (2) (relating to the relationship of stock to a decedent's estate) is amended by changing "35 per- cent" and "50 percent" to read "20 percent" and "40 percent", respectively. (b) Subsection 6166(a) (relating to payment of estate tax) is amended by changing "35 percent" and "40 percent" to read "20 percent" and "40 percent", respectively. EXHIBIT E PROPOSED CHANGE IN INTERNAL RI~VENUE CODE Transfers of Business Interests at Death. (a) Chapter 11 of Subchapter A of Subtitle B (relating to estate tax) is amended by adding at the end thereof the following new section: "Section 2057. Transfers of Business Interests at Death. In the case of a business interest qualifying under Section 303 or Subsection 6166(a), the beneficiary of such interest shall have the option of receiving said interest at the decedent's basis. In the event of the sale or exchange of said interest within two years of decedent's death for another business interest hav- ing a fair market value not exceeding $1,000,000, the tax basis of ownership of such other business interest shall be the same as that of the business interest acquired from the decedent." Mr. BtrRLLSON. Well, thank you, Mr. Pendergast. Do you know whether the case you just cited is common. Mr. PENDERGAST. I know a numer of cases. As a matter of fact, the only changes are synchronization with other cases where I have been involved, or other people I know have been involved. It is a very small business where the entrepreneur spent all his life trying to make the business go, and isn't concerned about estate planning because he thinks he is never going to die. Mr. BURLESON. Well, probably, but probably some of this is due to a lack of planning, is it not? Mr. PIENDERGAST. It is due to a lack of planning, Mr. Chairman, be- cause the man is spending his time creating his business; he hasn't got the time to plan. That business wouldn't be there if he stopped to plan; he would be planning for nothing. Mr. BtmI~soN. In the case you just cited, why did he not take ad- vantage of the deferred payment relief in section 6166? Mr. PENDERGAST. They did take some advantage of it, but it only gave them some relief. Mr. BURLESON. Didn't cover his situation? Mr. PENDERGAST. No, it didn't cover all the situation or administra-~ tion expense or other types of things involved. PAGENO="0407" 393 Mr. Bun~Esow. Mr. Duncan. Mr. DUNCAN. Thank you, Mr. Chairman. I have nO Other questions, other than to thank the panel, which I think is as good, if not better, than any other panel we have had today. Especially we welcome our former colleague. "Mike" McKevitt to the committee and thank all of you very much for coming. I know your information will certainly be helpful to us in our final decision. Mr. BTJRLESON. Mr. Pickle, you have a question? Mr. PICKLE. Well, I think the testimony that Mr. McKevitt and his group have presented is helpful. They come from a very respected group. We know at the beginning that information given to us by our former colleague would be very worthwhile information. We are glad he is here. I want to comment on the question that the chair asked Mr. Pender- gast and others-whether this is a matter of planning. Even if you try to plan under present law, you can't-there is an injustice and in- equity, as I see it. Do you agree with that? Mr. PENDERGAST. Yes, no question about it, Mr. Pickle. Had he been able to plan, he could have mitigated to some extent. Mr. PICKLE. Yes, yes. Mr. PENDERGAST. But wouldn't have been able to to defer them. The problem people don't understand, this business might be worth $500,- 000 in paper, but in fact to realize that $500i000 will destroy the busi- ness. Congress is fully aware of the concept of the tree as compared to the fruit. The tree being the company and the fruit being the income being yielded from the company. And what has happened to the estate taxes, the estate tax is like lightning striking the tree and destroying it. So estate tax is destroying the future fruit also. Mr. PICKLE. How many members belong to your three associations ~ Mr. PENDERGAST. There are eight associations involved, totaling over 450,000 members, members companies. Mr. PICKLE. Have each one of the~e groups officially gone on record in favor of your legislation?* Mr. PENDERGAST. That is correct. Mr. PICKLE. In the Eurleson bill? Mr. PENDERGAST. Basically the Burleson bill. Mr. PICKLE. The Burleson-Pickle bill, yes. Mr. PENDERGAST. As far as the exemptions go, Mr. Pickle, but there is something more than that. I think the eva~uation of the date of death is one thing I have spoken about which is a key problem. Mr. PICKLE. I see. Mr. PENDERGAST. It isn't addrèsed in any legislation. Mr. B1JELESON. Do you have any questions, Mr. Steiger? Mr. STETGER. No. thank you. Mr. MCKEVITT. May I respond to Mr. Pickle's comments, Mr. Chair- man? Mr. BtRLESON. Oh, yes, surely. Mr. MCICEVITT. Mr. Pickle, these groups met, coming from Cleve- land and Wisconsin, all øver the country, and retained counsel-for ex- ample, Charlie Noon, former Council for Small Business. We hav& done enough polling; enough people care, like Leo McDonnei from Pittsburgh, and Mr. and Mrs. Crosby here from Cleveland. Mr. Crosby is a businessm~u~ in Cleveland. So we have a continuing concern on PAGENO="0408" 394 this problem, and there is a great deal of concern about the inequities of estate tax. We see it in our membership mail all the time, so far as the correspondence that comes in. Mr. PICKLE. Thank you, Mr. Chairman. * Mr. BURLESON. Mr. Steiger, do you have a question? Mr. STErnER. Thank you, Mr. Chairman. I join in welcoming Mike back, as well as both Mr. Stewart and Mr. Pendergast. When is the bill going to be ready; at what point are you going to have a legislative draft? Mr. PENDERGAST. We expect it to be ready in a month. However, the sections of the estate and gift tax are attached to my legislation. Mr. STEIGER. I see them, thank you. Mr. PENDERGAST. Exhibits B, C, D, and E. Mr. STEIGER. Thank you. That is what I am looking for. Mr. PENDERGAST. We would welcome your introduction of that bill, Mr. Steiger. Mr. STEIGER. Oh, yes, I see them now. Thank you. Mr. BTJRLESON. Thank you very much, Gentleman, for coming. Mike, we are glad to see you again. Mr. MCKEVITT. Thank you, Mr. Chairman; very nice to be here. Mr. BURLESON. The next and last panel: Mr. John Nash, who is chairman of government relations of the National Automobile Deal- ers Association; Mr. William C. McCamant, executive vice president, National Association of Wholesaler-Distributors; Mr. Frank Mc- Carthy, executive vice president; and Kevin Tighe, legislative coun- sel. Are we missing one panelist? Mr. McCarthy, I guess.. Mr. NASH. Yes; Mr. McCarthy is not here, sir. Mr. BuRI~soN. Very good. John, we will lead off with you if we may. A PANEL CONSISTING OP JOHN NASH, CHAIRMAN, GOVERNMENT RELATIONS, NATIONAL AUTOMOBILE DEALERS ASSOCIATION, ACCOMPANIED BY KEVIN TIGHE, LEGISLATIVE COUNSEL; AND WILLIAM C. ]~IcCAMANT, EXECUTIVE VICE PRESIDENT, NA. TIONAL ASSOCIATION OP WHOLESALER-DISTRIBUTORS STATEMENT OP JOHN N. NASH Mr. NASH. Thank you very much, Mr. Chairman. One behalf of its 20,000 franchised new car and truck dealer members, the National Automobile Dealers Association welcomes this opportunity to express its views on the imperative need to raise the present exemption con- tained in the Federal estate tax law to reasonably reflect the major increases in inflation during the past 34 years. For the record, my name is John N. Nash. I am a Chevrolet dealer in Austin, Tex., and serve as NADA director for south Texas. I am also the chairman of NADA's Governmental Relations Committee for 1976. NADA and its small businessmen members feel very strongly that an ilicrease in the present $60,000 exemption from the Federal estate tax is long past due. The $60,000 exemption level `~vas set in 1942, nearly 35 years ago. I need only note that the Consumer Price Index has risen some 203 percent since the present exemption level was stablished to indicate a very good case for the need to raise the present exemption level. PAGENO="0409" 395 Ti~ effect c~ tI~i~ tremendous inf~atiouary growth has impacted with particu1a~ i~ieq~p~ty oi~ ~al1 businessmen such as franchised new cai and tru~k 4ealer~ in the area of the Federal estate tax In many cases the small businessman dealer's estate consists, for the most part, of non liquid assets, principally the real property and building of the dealer ship. Because of the unrealistio~liy low exemption level currently in ef- fect, the heirs of a dealer may be forced to liquidate these assets which the dealer worked a lifetime to acquire simply to pay the substantial estate tax due. NADA fee~s very strongly that this was not the intent of the Con- gress when it established the $~O,0O0 exemption level. NADA would argue that the Federal estate tax is not intended or shouldn't be in~ tended to force heirs of small businessmen to liquidate real property nonliquid assets which are the result of a lifetime of hard work by the decedent. Liquidation of such assets should be a matter of choice by the heirs ~f the estate, not a liquidation dictated by the need to pay substantial estate taxes due because of an outdated and totally unrealistic exemp- tion level. In a related matter, NADA feels that the estate tax law should make provisions for paying the estate tax due at no interest for at least the first 5 years and at a reasonable interest rate thereafter. This would permit the heirs, if they chose to continue the business or utilize the real property assets of the dealership for another business, to pay off the estate tax due without incurring potentially fatal cash flow prob- lems. This would be particuarly true during the first few years of the business's operation under the heirs. This would be particularly helpful to the successor operators of franchised new car and truck dealerships. Dealers having a franchise `Lgreement with a domestic automobile manufacturer can arrange prior to their death for a successor operator to be appointed. The successor operator is, however, subject in most cases to a trial period during the first 2 years of his or her operation of the dealership It would be patricularly helpful to these successor operators if the appropriate modifications to the estate tax law which `NADA is recom- mending were adopted. It would allow them to get their feet on the ground during the initial phase of their operation of the dealership without having to he concerned with the need to generate substantial amounts of ca~h to liquidate the potentially heavy estate tax liability. In short, NAJDA feels `that these successor operators of the dealer~ ship should be given a~ fair chance to prove themselves. This will also benefit the employees of the business by providing a better opportirn ity for avoiding a severe disruption to the employment situation at the dealershm This will benefit not only the employees of the dealership but also the eeon~mic health of the community. NADA is aware of a number of specific legislative proposals which have been intrrodue~d during the 94th Congress concernmg est'~te tax reform. Bills on `both the House and Senate side would' increase the present $60 000 estate tax exemption to various levels N~ DA feels that an increase to $200,000. as Conq~ressman Burleson's bill, H.B. 1793, calls for, is the most appropriate level at which to set the new exemptibn leveL Oonsidering the 203-percent increases `in the consumer q~ice index since 1942, establishing the new exemption level PAGENO="0410" 396 ~t this figure would simply place the exemption level back at the same level as in 1942 in terms of real purchasing power. Thus, setting the new exemption level ~t $200,000 would simply ~tinount to adjusting the level to reflect the current value of the dollar as ~compared to 1942. NADA believes that such an adjustment to reestab. lish the real value of the estate tax exemption is in the best interests of the Nation and in line with the original congressional intent when enacting the Federal estate tax law. The tax was never intended, in NADA's view, to apply to the average small businessman, independent family farmer or middle-class wage earner but rather was intended to place a tax on the extremely wealthy to prevent the extraordinary and undesirable accumulation of assets, through inheritance, in the hands of the few. Raising the exemption to $200,000 will focus the' application of the Federal estate law on those individuals in our society that the Con- gress, in enacting the Federal estate tax law, intended the tax to be applicable to. NADA is also cognizant of the serious problems which the present ~estate tax exemption level is causing in the area of family farm~ located near expanding metropolitan areas. Since under the current law the farm property is valued at fair market value, the vastly in- creased value of farmland near large, expanding metropolitan areas is making it most difficult for family members heirs of decedent farm- ~ers to continue to utilize the property for farm purposes. While it would be inappropriate for NAI)A and it~ members to make specific reform suggestions in this area of estate tax reform, NAIIDA would like to indicate to the committee its strong sympathy for these fellow small `businessmen and their heirs and'would like to express a strong philosophical stand in favor of removing estate tax burdens which force the heirs of small businessm~n, inôluding the `family farmer, to liquidate real property assets `in order to meet a substantial estate tax liability. Surely the estate tax laws should encourage-rather than dlscour- age-the continuation of this important American institution, the family held and operated farm. In summary, it is somewhat ironic that the hea~tiest burden of `the Federal estate, tax now falls on individuals that' Congress never ~ntended the tax to apply to in `any substantial ni~th~bers. Raising of th~ `exemption level to $200,000 will serve to return the focus of the estate tax's application to those' that Congress intended to be coveted and subject to its requiremeni~s. As a matter of basicf~irness and equity, NADA would strongly urge this' committee and' the Congress to sp~edily enact this gr~atly needed reform to the Federal estate tax law. Thank you very much, sir. Mr. BTJRLESON. Thank yoi~i, Mr. Nash. Mr. Tighe or Mr. M~Camapt, whichever wa~ you may wish. Mr. TIGHE. Not at this time, Mr. Chairman. Mr. BURLESON. Then do you have anything' to add, Mr. MeCamant? STATEMENT O~' `WILLIAM C. MCCA1V ANT Mr. MCCAMANT. Yes ;I would be glad to. `I am William C. MeCamant, executive vice president of the Na- tional Association of Wholesaler-Distributors, in Washington, D.C. The National Association of Wholesaler-Distributors (NAW) is a PAGENO="0411" 397 federation of 98 national commodity line associations which in turn zare composed of over 32,000 merchant wholesaler and distributor establishments located throughout the 50 States. Sales by merchant wholesaler-distributors are forecast by the De- partm~nt of Commerce to reach $498 billion in 1976. The association ~estimates that NAW affiliates account for approximately f~0 percent of total industry sales, and 60 percent of the over 4 million individuals ~employed in wholesale trade. At this point, Mr. Chairman, I will ask that the rest of my state- ment be placed in the record, and I would like to comment. Mr. BURLESON. Without objection, your full statement will be in- cluded in the record. You may proceed. Mr. MCCAMANT. Thank you. The question has been raised as to how this affects businessmen. We have heard a great deal on farmers, and I would like to elaborate a bit ~n the average wholesaler-distributor. He typically has 20 or 30 employees, he has got money tied up in land, primarily warehouse and a great deal tied up in inventory, and ~accounts receivable. Generally every time that you increase your sales $5,000 during the year you almost increased your accounts receivable by $2,500 during that year. So as the business grows you have a constant need for more capital. Longress has recognized time after time significant changes in the value of the dollar. I think the minimum wage was 25 cents, for exam- ple, when the $G0,000 estate tax exemption was put in. Congress has increased social security taxes and benefits as well as Federal wages. There has been all sorts of increases that Congress has given to recog- nize the inflationary aspect. But there has been no recognition in the law through all these years in connection with the survivors, and the continuation of smaller business enterprises. At a recent meeting that we held in Florida, we presented this prob- lem to the wholesalers and they were much concerned about it. They passed a ;resolution and, as ~nany of the other associations here repre- sented, we. also had a session on this for the wives, and the wives were really up in arms as they had no idea that it is just a mere $60,000 before the Government is going to step in and start taxing the pro- ceeds of the estate. Now, these, are w~men who have children, you know, 12, 14, 16 year `olds, with a long road ahead of them. They have devoted their time to their children, and to realize that at that level the Government is going to step in and tax, that' was a great surprise. They even said quite in~iignantly to me why didn't their husbands bring home thesereports we were presenting to them, which was a very ~good question. `But it does mean that there is an encot~ragement for business to sell or to merge, and I don't think that that is what the Congress wants. I think Congress wants business to continue. We pay the Department ~of Justice and the' 13'ederal Trade Commission constantly in order to investigate mergers and acquisitions~ and T think the congressional policy should become consistent, the tax policy should be brought in line in connection with what is public policy. And public policy is to diseonra~e mergets and acquisitions. I should also like to note we support many of the measures which ~have been stated; first, to increase the deduction ana, second, to ease the payment of the tax, because cash is hard to raise. PAGENO="0412" 398 Fox' instance~ making an estate tax return within a year is extremely difficult. I believe the members of this couimhtee who ~re mostly attorneys realize how difficult that is, and in a closely held business you can't go out and borrow. What is likely to happen when the owner of the business dies? Is it likely the banks will extend more money? No; the most likely thing for the banker to do is to call in the loan, or to try to get the loan reduced. So the business itself is at a crucial point because the man- ager of the business is gone, and therefore the probability of being able to meet the critical financial situation in such a short time is extremely difficult. And this is one of the problems that is going on right now. So with that I will close. I might say that the average wife is about 3 years younger than her husband, and she is going to live 3 or 4 years longer than him. So the problem really rests with the women who are forced to cope with it. We appreciate the bills that have been introduced by members of this committee, and also by Senator Nelson and Senator Brook on the Senate side. [The prepared statement follows :J STATEMENT OF WILLIAM C. NCCAMANP, NATIONAL ASSOCIATION OF WHOLESALER- DISTRIBUTORS I am William C. MeCamant, Executive Vice President of the National Association of Wholesaler-Distributors, In Washington, D.C. The National Association of Wholesaler-Distributors (NAW) is a federation of 98 national commodity line associations which in turn are composed of `over 32,000 merchant wholesaler and distributor establishments located throughout the 50 states. Sales by merchant wholesaler-distributors are forecast by the Department of Com- merce to reach $498 `billion In 1976. The Association estimates that NAW affiliates account for approximately 60% of total industry sales, and 60% of the over 4 million individuals employed in wholesale trade. Our members, consisting preponderantly of smaller, closely-held, family- owned firms, have a vital interest hi the impact of taxes on the continuation of smaller `business enterprises. We are particularly concerned with the matter of estate taxation, which already poses a serious problem for many wholesale distribution firms. The President's proposal and many other bills which have been introduced In the Congress take note of this situation. The degree to which estates are taxed will have a great effect on whether the closely-held business can be perpetuated beyond the life of the present principal owner. Smaller, closely-held firms, whether they be wholesale distribution firms, retail firms, or manufacturIng firms-all play a significant role In the productivity and growth of our economy. We are here today to prge the Congress to take action to correct a situation that threatens the very existence of a viable smaller business entity lr~ our nation-the present system of estate taxation. We wish today to present our recommendations for reform in this area, which we believe would assist measurably in the continuation of the smaller business enterprise, both in the wholesale distribution industry and the economy as a whole. INC~EAS~ THE SPECIFIC ESTATE TAX EXEMPTION TO $200,000 At the present time, the first $60,000 of net personal wOrth of a deceased Is exempt from the Federal estate tax. That exemption level was established in 1942. No change has been made In this level of exemption despite the change in the purchasing power of the dollar. The members of this Committee recognized a similar Inflation last year when they took action to Increase the corporate surtax exemption to assist in capital formation. The fact that Congress has made no change in the estate tax law does not mean that no change has occurred. Indeed, a. very significant chapg~ has occurred for the heirs of the deceased and for the future of the `business. PAGENO="0413" 399 The effects of fti1littit~i on estates hare been dramatic, alid ~ia~e re~u1ted in iiuge ta~ liabilities which the biisIfle~s n~ust pa~ wheil raced with the death of a ~r1iicflia1 Owner. ~The f1~ures indicate that the GNP Irnp1i~It Price Deflator-one measure of the price level-has IncreaSed 250% sInce 1942. Thus, the value of the $43ff~0O0 exemption Congress approved In 1942 would now equal approximately $17,100; conversely, the Pu~~r~hasing power of $60,000 In 1942 would now equal approximately $210,000. It should be noted that the current tax on an estate of $210 000 Is $65 700 yet no ~Oderal estate taE would have `been due on the sante amount of purchasing power in 1942. We recommend the Congress remedy this situation by Increasing the estate tax exemption to $200,000. REVISE ESTATE TAX STEiIOT~1iE Another aspect of eState. taxation irhich requires examination is the rate structure. Inflation has distorted the Intent of the Congress In this regard as well. The attached table demonstrates the application of the tax rate `in 194~ dollar values to 1976 third quarter dollar values. In the interest of returning parity to the estate tax structure, the tax brackets should be adju8ted to reflect present dollar values. ror example, the $20,000 to $80,000 1942 tax bracket was taxed at a marginal rate of 14%. However, with inflation, that dollar value `bracket is flow $70,200 to $105,200, taxed at a marginal rate of 28%-a 100% Increase in the marginal tax rate at a relatively low estate value. The impact of inflation has been such that a 1942 estate of $3 million (originally intended to be taxed at a marginal rate of'56%) is now equal to approximately $10.5 million, and Is taxed at the maximum marginal rate of 77%. NAW therefore recommends that the Congress revise the tax brackets to restore parity. EASE TAX PAxMExT Any discussion regarding methods of easing the tax burden on closely-held business must of necessity Include consideration of the options available to the heirs of the closely-held business for payment of the estate tax. Remittance of the total amount of estate tax due presents often Insurmountable difficulties to the closely-held business. Such a large sum of cash can only be obtained in a very few ways--through the sale Of stOck, proceeds from a loan, or cash on hand. It must be remembered that stock in `a closely-held business is not easily saleable, as there is not a ready market compared to ~t~ck traded on an exchange. Banks are not a likely source of additional funds for the closely- held business during this time, as the future of the business is extremely un- certain due to the death of a `principal. Payment of the tax with cash on hand- if this is even possible-~would so severely `hamper the daily operation of the business `as to effectively preclude its continued growth and profitability. The Congress recognized the tremendous problems encountered by the closely held business with regard to payment of the estate tax, and included within the Internal RevOnue `Code provisions which allow for an extension of time for payment. flowever, in practice, such provisions are of little assistance, mainly because of the stringent criteria set down in the Code. NAW firmly believes the effectiveness of these sectlon~ of the Code would be greatly enhanced by the adoption of the following recommendation's: (1) Increase the time allowed for filing and payment of estate taxes from the present 9 months to at `least one year. (2) PermIt installment payment in any case of simple hardship by striking the word "undue" from the present h~rdship sOction of the Code. (Section 6161) (3) Ease requirements of SectIon 6166 (pertainIng to an interest In a closely- held business) by Increasing the allowable nu~'ber of silareholders from. the present 10 to 15 and reducing percentage requirements for the decedent's Interest in the `closely~held business from the present 35% Of, gross estate or 50% of taxable estate to 20% of gross estate or 35% of taxable estate. (4) Increase the present 10 year maximum repayment period allowable under both Sections 6161 and 6I6~ to 15'years. CAPITAL GAINS OF A5S~PS ~EANSFEEaED A~ hEATs Additionally, we note that SomO t~ pto~Osals pendlnk before the ~ohgress contain provimotis Imposing a capital gains tax on assets transferred at death Such a tax would sound the death knell for small busInesses such as those en- gaged in wholesale distribution. PAGENO="0414" 400 Those who favor such a tax that unrealized appreciation of capital assets,. regardless of kind, is income which currently escapes taxation when held until death. They maintain that this unrealized capital gain should be taxed as if it had been sold the day before death. To the typical wholesale distribution firm, a tax of this nature, couple~ with existing high estate taxes due, would most probably preclude the per- petuation of the business. We urge the Congress not to~ apply a capital gains tax to an imaginary gain. Taxation of a gain founded only on the assumption that it has in fact occurred is not a realistic basis for taxation. CONCLUSION OF SUMMARY Mr. Chairman, we are certain that you and the other members of this Com- mittee recogisize the gravity of this problem and share our concern for the continuation of a viable small business sector in our economy. Estate taxation poses a very real problem to the perpetuation of these firms, and we therefore urge your consideration of our recommendations. Mr. Chairman, I would appreciate the opportunity to extend these remarks, and file a more extensive document in support of our recommendations for the bearing record. EQUIVALENT ESTATE TAX STRUCTURES, 1942 AND 1975 RATE TABLE FOR TAXABLE ESTATE * (A) (B) Taxable estate equal to or more than- Taxable estate less than- Tax on amoun 1942 tin col. (A) 1975 equivalent Ra te of tax on excess over Col. A 1942 1975 1975 1942 etuivvlent 1975 1942 equivalent * 0 0 5,000 17,550 5,000 17,550 10,000 35,100 10000 35,100 20,000 70,200 20,000 70,200 30,000 105,200 30,000 105,000 40,000 140,300 40, 000 140, 300 50, 000 175, 400 50,000 175,400 60,000 210,500 60, 000 210, 500 100, 000 350, 800 100, 000 350, 800 250, 000 877, 100 250,000 877,100 500,000 1,754,200 500 000 1,754, 200 750, 000 2, 031,300 750,000 2,631, 300 1,000,000 3, 508,400 1 000, 000 3, 508, 400 1, 250, 000 4, 385, 500 1 250 000 4, 385, 500 1, 500, 000 5, 262,600 1500,000 5,262,600 2,000,000 7,016,800 2 000,000 7,016,800 2,500,000 8,771,000 2 500 000 8,771,000 3,000,000 10,525,200 3 000,000 10 525,200 3,500,000 12,279,400 3 500, 000 12, 279, 400 4, 000, 000 14, 033,600 4 000 000 14, 033, 600 5, 000, 000 17, 542, 000 5 000 000 17, 542, 200 6, 000, 000 21, 050, 400 6 000 000 21, 050 400 7, 000, tOO 24, 558, 800 7 000 000 24, 558, 800 8, 000, 000 28, 067, 200 8, 000, 000 28, 067, 200 10, 000, 100 35, 084, 000 10, 000, 000 35, 084, 000 0 150 500 1,600 3,000 4, 800 7,000 9, 500 20, 700 65,700 145, 700 233,200 325,700 423, 200 528,200 753,200 998,200 1,263,200 1, 543, 2410 1, 838, 200 2, 468, 200 3, 138, 200 3, 838, 200 4, 568, 200 6, 088, 200 0 1,330 3,918 12,356 22,620 32, 790 43,320 53, 850 100, 260 280,22.7 642, 590 1, 067, 789 1, 548, 156 2, 081, 065 2,644,142 3,850,464 5,154,160 6,492,604 7, 843, 338 9, 194, 072 11, 805, 540 14, 597, 008 17, 298, 476 19, 999, 944 25, 402, 880 3 7 11 11 18 14 28 18 30 22 30 25 30 28 30 30 32 32 37 35 45 37 39 59 42 63 45 67 49 73' 53 7~; 56 77' 59 77 63 77' 67 77 70 77 73 77 76 77 77 77 Source: A guide to Federal estate and gift taxation, Internal Revenue Service, 1972. Equivalents are derived fron implicit price defl41tor. Mr. BURUOSON. Your main reference is to the 9-month settlement. Mr. MOCAMANT. Well, that is one thing, but we also think the exemp- tion certainly should be raised. Mr. BURLESON. `What additional period in your opinion should the ~ months be extended? Mr. MOCAMANT. Well, we would think that it should be a minimum ~f 1 year to 15 months with original filing, and then when there is hardship continues for 10 years, but we will also believe that the words PAGENO="0415" 401 "undue hardship" has ~au1ted*in the Internal Revenue Service going to the very extreule onth~ term "trndue." Mr. BIJBLESON, I believe it was 15 months prior to January 1, 1971, amlcorrect? Mr. NA~ii. Yes~, sir, correct. Mr. MOCAMANT. 4nd that was done, that was one of these tricks t~ inc~rea~e revenue, you 1~now. To bring up revenue, that is the reason it was done. They~ did the. same thing once with filing of withholding, I believe, iii orde~rto speedit up, the filing o~f withholding taxes, in order to overco~ne a deficit ~ituat~on. Mr~ BURLI~$ON. 1 i~aust admit that in 1971 I was sitting right here and ~I. must admit I found out about this~somewhat after that action was t~tken, but I never really understood the Treasury's rationale for it.' Mr. Pwic~an, do yoi~i~ a question? : Mr. DthcCAN. I have no question, other than to thank the panelists fortheirl?rery fin~ presentatiops. Mi'. BUELE~0N. Mr. Pi~l~le. Mr. PIc1u~E. Mr. Chaii'man, I ~uyould like to express my appreciation for the testimony. It is paj~tieu1arly good to see you, Mr. Nash, here. You' have appeared "before our committee. You are one of the most respe~ted~I5usinesmen in Austin and in central Texas. Mr. Chairman,. he and his family have been very valuable members of our business community for hMf a century pr longer. So I know, that when he comes h~ brings with him the reputation of a very ho1~orab~te and'spccessful businessman. Bill, before the hearing started, I had thought in terms of developing a bi'U that would primarily help farmers and ranchers, and though that is the case, it would ailso apply to many small businesses, I notice Mr. N~sh was pøinting out that.~ person with a nonliquid asset, particu- larly the property, is dealt a hard blow right at first if this tax is not raised. So its relief goes across the board. It helps more than just a select group. It~wonld help small businesses, and I see that even more clearly now as the hearings have progressed. Your testimony is very important to us. SoT am glad to have t~hat. Mr. NASH. Thank `~rou vei'y much, Mr. Congressman. We feel it i~ one of the most unfair taxes when it hasn't been updated since 1949, compared to the cost of living which has increased 203 percent. Mr. PIcI~LE. It was fair in the beginning, but in the face of 30, 35 years it has become unfair, and we do need to update it. Mr. BtRL~SON. 1 don't want to blame' you all for campaigning a little bit, but I am sure you are ~upporting. Mr. NASH. I love to see you here, Mr. Chairman. Thank you for being present. Mr. BURL~SON. Mr. Steiger, do you have any questions? Mr. STErGtR. After thwt comment I wouldn't dare. Mr. BtTRLES0N. Thnnk you very much, gentlemen, for coming. Mr. MOCAMANT. Mr. Ohairm~n, may I have leave to file in addition to my short state~nent `a technical economic statement for the record?' Mr. BTJRLESON. Without objection, that will be included in the recor& [The statement follows:] PAGENO="0416" 402 ADDITIONAL STATEMENT OF WILLIAM C. MOciAMANT, E~EECUTIV]t Vicn Pnssnnwr, NATIONAL AsSoCIATIoN OF WH0LE5A.ram-DISTRIBUT0ES I am William C. M~Oamant, Executive Vice President of the National Asso- elation of Wholesaler-Distributors, in Washington, D.C. The National Association of Wholesaler-Distributors (NAW) Is a federation of 98 national commodity line associations which in turn are composed of over 132,000 merchant wholesaler and distributor establishments located throughOut the 50 states. sales by taerchant wholesaler-distributors are forecast by the t~epartinent of Commerce to reach $498 billion in 1976. The Association estimated that NAW affiliates account for approximately 60% of total industry sales, and 60% of the over 4 mIllion Indi- viduals employed in wholesale trade. Our members, consisting preponderantly Of smaller, closely-held, family- owned firms, have a vital interest in the impact of taxes on the continuation of smaller business enterprises. We are particularly concerned with the matter of estate taxation, which already poses a serious problem for many wholesale dis- tribution firms. The President's proposal and many other bills which have been introduced in the Congress take note of this situation. The degree to which estates are taxed will have a great effect on whether the closely-held business can be perpetuated beyond the life of the present principal owner. Smaller, closely-held firms, whether they be wholesale distribution firms, ~~ta1t firms, or manufacturing firms-all play a significant role In the productivity and growth of our economy. We are here today to urge the Congress to take action to correct a situation that threatens the very existence of a viable smaller business entity in our nation-the present system of estate taxation. We wish today to present our recommendations for reform in this area, which we believe would assist measurably in the continuation of the smaller enterprise, both In the wholesale distribution Industry and the economy as a whole. INCREASE THE SPECIFIC ESrATE TAt EREMPTION TO $200,000 At the present time, the first $60,000 of net personal worth of a deceased is exempt from the Federal estate tax. That exemption level was established in i94~. No change has been made In this level of exemption despite the change In the purchasing power of the dollar. The members of this Committee recognised a similar inflation problem last year when they took action to increase the corporate surtax exemption to assist In capital formation. The fact that Congress has made no change In the estate tax law does not mean that no change has occurred. Indeed, a very significant change has occurred for the heirs of the deceased and for the future of the business. The effects of inflation on estates have been dramatic, and have resulted in huge tax liabilities which the business must pay when faced with the death of a principal owner. The figures indicate that the GNP Implicit Price flefiator- one measure of the price level-has increased 250% since 1942. Thus, the value of the $60,000 exemption Congress approved in 1942 would now equal approxi- mately $17,100; conversely, the purchasing power of $60,000 in 1942 would now equal approximately $210,000. It should be noted that the current tax on an estate of $210,000 ts $35,700, yet no Federal estate tax would have been due on the same amount of purchasing power in 1942. We recommend the Congress remedy this situation by increasing estate tax exemption to $200,000. REVISE ESTATE TAX STRUCTURE Another aspect of estate taxation which requIres examination Is the rate structure. Inflation has distorted the intent of the Congress in this regard as well. Table 6 demonstrates the application of the tax rate in 1942 dollar values to 1975 third quarter dollar values. En the interest of returning parity to the estate tax structure, the tax brackets should be adjusted to reflect present dollar values. For example, the $20,000 to $30,000 1942 tax bracket was taxed at a marginal rate of 14%. However, with inflation, that dollar value bracket Is now $70,200 to $105,200, taxed at a marginal rate of 28%-a 100% Increase In the marginal tax rate at a relatively low estate value. The impact of inflation has been such that a 1942 estate of $8 million (originaly Intended to be taxed at a marginal rate of 56%) is now equal to approximately $10.5 million, and Is tated at the tuaximnin PAGENO="0417" 403 marginal rate of 77%. NAW therefore recommends that the Congress revise the tax brackets to restore parity. EASE TAX PAYMENT Any discussion regarding methods of easing the tax burden on closely-held business must of necessity include consideration of the options available to the heirs of the closely-held business for payment of the estate tax. Remittance of the total amount of estate tax due presents often insurmountable difficulties to the closely-held business. Such a large sum of cash can only be obtained in a very few ways-through the sale of stock, proceeds from a loan, or cash on hand. It must be remembered that stock in a closely-held business is not easily saleable, as there is not a ready market compared to stock traded on an exchange. Banks are not a likely source of additional funds for the closely-held business during this time, as the future of the business is extremely uncertain due to the death of a principal. Payment of the tax with cash on hand-if this is even possible- would so severely hamper the daily operation of the business as to effectively preclude its continued growth and profitability. The Congress recognized the tremendous problems encountered by the closely- held business with regard to payment of the estate tax, and Included within the Internal Revenue Code provisions which allow for an extension of time for payment. However, in practice, such provisions are of little assistance, mainly because of the stringent criteria set down in the Code. NAW firmly believes the effectiveness of these sections of the Code would be greatly enhanced by the adoption of the following recommendations: (1) Increase the time allowed for filing and payment of estate taxes from the present 9 months to at least one year. (2) Permit installment payment in any ease of simple hardship by striking the word "undue" from the present hardship section of the Code. (Section 61(11) (~) Ease requirements of Section 6166 (pertaining to an interest in a closely- held business) by increasing the allowable number of shareholders from the pres- ent 10 to 15 and reducing percentage requirements for the decedent's interest in the closely-held business from the present 35% of gross estate or 50% taxable estate to 20% of gross estate or 35% of taxable estate. (4) Increase the present 10 year maximum repayment period allowable under both Sections 6161 and 6166 to 15 years. CAPITAL GAINS ON ASSETS TRANSFERRED AT DEATH Additionaly, we note that some tax proposals pending `before the Congress con- tain provisions imposing a capital gains tax on assets transferred at death. Such a tax would sound the death knell for small businesses such as those engaged in wholesale dlstriibution. Those who favor such a tax argue that unrealized appreciation of capital as- sets, regardless of kind, is income which currently escapes taxation when held until death. They maintain that this unrealized capital gain should be taxed as if it had been sold the day before death. To the typical wholesale distribution firm, a tax of this nature, coupled with ex- isting high estate taxes due, would most probably preclude the perpetuation of the business. We urge the Congress not to apply a capital gains tax to an Imaginary gain. Taxation of a gain founded only on the assumption that it has in fact occurred Is not a realistic basis for taxation. CONCLUSION QF SUMMARY Mr. Chairman, we are certain that you and the other members of this Com- mittee recognize the gravity of this problem and share our concern for the con- tinuation of a viable small business sector in our economy. Estate taxation poses a very real problem to the perpetuation of these firms, and we therefore urge your consideration of our recommendations. Mr. Chairman, I would appreciate the opportunity to extend these remarks, and file a more extensive document in support of our recommendations for the hear- ing record. 68-872 0 - 76 - 27 PAGENO="0418" 404 ESTATE TAXATION AND THE WHOLESALE DISTRIBUTION INDUSTRY STRUCTURE AND ECONOMIC SIGNIFICANCE OF THE WHOLESALE DISTRIBUTION INDUSTRY The wholesale distribution industry, iii contrast to the manufacturing sector of the economy, continues to be dominated by small closely-held family-owned busi- nesses. Of the roughly 300,000 merchant wholesale-distributors, approximately 90% had assets of less than $1 million in 1971. These smaller firms accounted for about 40 percent of the industry sales volume. In contrast, in the manufacturing sector, about 12% of the firms control about 95% of the assets and account for approximately 90$% of the sales. In addition, the wholesole distribution imidustry provides year-round employ- meat for 4.2 million individuals. Average hourly earnings (~$5.02) in the whole- sale trade i~n December, 1975, significantly exceeded those for all private industry (4.68), while aveage weekly earnings ($193.77) were 14.1% above those for all private industry ($169.90). In short, the wholesale distribution industry has generated a steady growth in dependable, well-paying jobs throughout the U.S. economy. Merchant wholesaler-distributors also perform an essential economic function. They make goods and commodities of every descriptioli available at the place of need, at the time of need. Wholesaler-distributors purchase goods from producers, store, break bulk, sell, deliver and extend credit to retailer dealers, and industrial, commercial, institutional, governmental and contractor business users. Wholesaler-distributors are essential to the efficient distributiomi of our every- day consumer and business needs. Further, by the market coverage which they offer suppliers and the support which they provide customers, they preserve and emihance conipetition, the critical safeguard in our economic system. According to a recent NAW survey, the tyl)ical wholesaler-distributor establishes the market connection between 133 manufacturers and 533 business customers. Many of these manufacturers are themselves small businessmen who must rely on whole- saler-distributors to establish, niaimitain and nurture markets for their products. Many customers are small businesses also who look to the merchant wholesaler to provide merchandise availability, credit and other services. PERPETUATION IN THE WHOLESALER DISTRIBUTION INDUSTRY The economic data which has beemi cited to this point demonstrates much about the structure and composition of our industry. On another level, however, NAW initiated a broad study project to gaimi precise understanding of the actual ownership amid perpetuation status of U.S. wholesaler-distributors. The survey, conducted in 1973-74, involved 38 conimodity line associations and was dis- tributed to 18,000 individual firms. Aim astounding 5,000 firms responded, of which 4,700 were useable for the computerized amialysis. The analysis was conducted by Robert C. Bansik, Ph.D., amid Harold Squire, Ph.D., of the Capital University Graduate School of Administratiomi in Columbus, Ohio. Data collected through NAW's Perpetuation Survey revealed mnucli about the individual wholesale dis- tribution business, and its ability to exist in its presemit form beyomid one genera- tion. The following typical owmiership profile was determnined fromii the survey results: (1) The firm has a net worth of between $250,000 amid $499,000. (2) The Chief Executive Officer (CEO) himself owns from 51 to 74 percent of the firmii's outstanding stock. (3) The CEO is between 50 amid 59 years of age. (4) The CEO's personal mnaximnum federal tax bracket is imi the range of 35 to 49 percent. (5) His ownership in the company represents from 51 to 74 percomit of the CEO's personal net worth. (6) Less than $100,000 imi life insurance on the CEO is owmied by the corpora- tion, and payable to it upon the death of the CEO. (7) The most probable successor to the CEO is either a soii or a non-relative. Based upon the deterniination of the typical ownership profile, the NAW Per- petuatiomi Survey sought. to answer the following question: "What is the likeli- hood that this firm can be perpetuated beyond the life of the presemit Chief Executive Officer, in its present form ?" The researchers concluded that: "imi fact, given the present situatiomi of U.S. inheritance/estate taxation and valuation, perpetuation in its present form niay be highly unlikely." PAGENO="0419" 405 The urgency of this problem cannot be emphasized strongly enough. Standard mortality tables, accurate to within a fraction of a percent, permit a very realistic projection of how many people, in various age groups, will die during any specified future period. Table 1, based on the "Commissioners' 1958 Standard Ordinary Table of Mortality~', in conjunction with age data provided `by the NAW Per- petuation Survey respondents in 197~-74, indicates that at least sixty-one of the almost 4,800 owners replying had died by the end of 1975. Chief Executive Officers of the firms surveyed are dying at the rate of at least one per week. Table 1 also shows that nearly eight percent-or 363-of the owners reporting will have died before 1980; 19 percent, or 875, will have died before 1985. The figures may be morbid, but they are clear: one in every five chief executive officers of wholesaling firms (and indeed of small business in general) faces death before 1985. The statistical figures shown are for general mortality, we expect data for stressed businessmen would be higher-accelerating the death rates for the respondents of the survey. TABLE 1.-AGE DISTRIBUTION AND MORTALITY ` De aths by 1975 Expec ted deaths b y 1980 Expe cted deaths b~ 1985 Number Actuarial Deaths Number Actuarial Deaths Number Actuarial Deaths Age reported reporting age b~ 1975 reporting age by 1980 reporting age by 1985 Under 40 434 40 1.5 423 40 9 423 40 22.0 40 to 49 1,235 45 6.6 1,235 45 39 1,235 45 147.1' 50to59 1,817 55 23.6 1,817 55 167 1,817 55 359.1 60 plus 1, 266 60 29.6 1, 266 60 148 1, 266 60 364.4 Total 61.3 363 874.5 Source: NAW Perpetuation `Survey, 1975. Over the years, the problem of perpetuation has gained In promience for the owner or chief executive officer of a wholesale distribution concern as he plans for the disposition of his estate upon his death. The tax crunch resulting from present estate taxes becomes a major concern to everyone faced with this problem. The tremendous estate tax liab~llties which are certain to come due upon the death of a principal' owner of the .sniall wholesale distribution business leave the heirs of the estate with few options-pay up with cash on hand, or sell or merge the busi- ness to generate the needed amount of cash. Payment of the estate tax, regardless of which of the above methods are em- ployed, will' adversely affect the economic health of the small business com- munity-by reducing the funds available to the smaller `business for continued growth, or by outright extinction of the small business firm through sale or merger. Statistics clearly demonstrate the economic value of our nation's small busiL ness community. Small business provides 52 percent of all private employment, and approximately % of the Gross National Product. However, the statistics can- not possibly measure the contribution which small business makes to the Ameri- can way of life. We have long recognized the tremendous impact of public policy on the preser- vation of a viable small business community in our nation, and have repeatedly called attention to the unique needs and problems of the small business commu- nity. This concern has been shared by the Congress, as is evidenced by the creation of the Small Business Administration, whose sole purpose was the preservation of a viable small `business sector in the economy, the establishment of small busi~- ness committees in both the House and the Senate, and various pieces of legisla- tion, such as the Tax Reduction Act of 1975, ~whlch include measures specifically designed to aid small businesses. Despite this recognition and awareness on the part of the Federal government, nothing can stop small business from dying a gradual death unless reform meas- ures are enacted to equalize the impact of estate taxation on small business. We recognize the fact that the estate tax system was never intended by the Congress to impact in any adverse manner on the small business community. However, the application of the law In today's economy has in fact done so-a consequence completely at variance with the Intent of the Congress. PAGENO="0420" 406 TABLE 2.-IMPLICIT PRICE DEFLATOR FOR GROSS NATIONAL PRODUCT, SELECTED YEARS, 1940-75 Year Annual rate of percentage Implicit price change from deflator precedin (1958=100) perio 1 3d quarter figure. Source: Economic Report of the President, January 1973 (p. 198); Survey of Current Business, December 1975. ESTATE TAX SPECIFIC EXEMPTION The burden of estate taxation has fallen increasingly on small businessmen and other middle-income taxpayers in recent years. The basic cause for this has been the long-term inflationary trend in our economy. No one should need to he re- minded of the tremendous erosion which has occurred in the value of the dollar over the years. However, a few examples of price levels in 1942 (the year in which the specific exemption of $60,000 was established) are recalled here for purpose of illustration: in 1942, average weekly earnings of production workers were $36.65, round steak sold for 434 per pound, sugar sold for 74 a pound, and imported petroleum crude oil sold for 3.24 per gallon. Overall, the price level has increased over 250% over the past 34 years (measured by the GNP Implicit Price Deflator). See Table 1. It is readily apparent that the cost of living has increased at a tremendous rate-from 1971 to 1975 alone, the Consumer Price Index has increased 33%, using average annual figures. But too often, the fact is ignored that the cost of dying has also increased. Changes in the income tax exemption have been made numerous times over the years to account for the rising cost of living, but no corresponding changes have been made in the level of the estate tax exemption since 1942. If the estate tax exemption had been "in- dexed" over the years with the GNP Implicit Price Deflator, the following table indicates what would have been the result: TABLE 3.-Estate ta~r ecemption adjuste~i for ch~ange in Implicit Price Deflator since 1942 Eweinptlon Year: equivalent 1942 $60,000 1950 90, 720 1960 116,880 1970 153,000 1974 192,000 1975 210, 504 We can see from the table that, based on the decreased purchasing power of the dollar, the exemption in 1975 would have equalled $210,504, if the same amount of purchasing power was to be exempted from the Federal estate tax. It should be noted that the current estate tax on the $210,000 estate is now $35,700, but no Federal estate tax would have been due on the same amount of purchasing power in 1942. 1940 43.87 1942 53.03 10.0 1945 59.66 6.3 1950 80. 16 6. 1 1955 90.86 2.5 1960 103.29 2.6 1961 104.62 1.3 1962 105.78 1.1 1963 107.17 1.3 1964 108.85 1.6 1965 110.86 1.8 1966 113.94 2.8 1967 117.59 3.2 1968 122.30 4.0 1969 128.20 4.8 1970 135.23 1971 141.61 1972 145.88 3.0 1973 154. 31 5.8 1974 170.18 10.3 1975 1186.05 9.3 Percent change: 1940-75 - +324.1 1942-75 +250.8 PAGENO="0421" 407 Therefore, NAW recommends the specific exemption be increased to $200,000. We fully recognize that, should the exemption figure be increased in accordance with our recommendation, the impact on the revenue derived from estate taxes would be sizeable. However, it must be remembered that total revenues from estate and gift taxation represent only 1.99 percent of total federal revenues. (Table 4) When considering the total economic impact of this proposal, this fact should be kept in mind. TABLE 4.-REVENUE SIGNIFICANCE OF ESTATE TAX REVENUES TO FEDERAL BUDGET RECEIPTS, SELECTED YEARS, 1959-72 [Dollar amounts in millionsi Share of . Federal Federal budget receipts attributable Year budget receipts Estate taxes to estate taxes (percent) 1959 1961 1963 1966 1970 1972 $79,249 94,384 106,560 130,856 193,743 208,649 $1,186 1,619 1,841 2,414 3,000 4,153 1.50 1.72 1.73 1.84 1.55 1.99 Source: Economic Report of the President, January 1973 and January 1976; Internal Revenue Service, "Statistics of Income: Estate Tax Returns," 1969 and 1972. However, if economic conditions and budget considerations should preclude this Immediate increase in the specific exemption, NAW would not be adverse to adoption of a "phased-in" method of increasing the exemption, as has been pro- posed by the President, as well as by many members of Congress. Overall, the effects of inflation over the years with regard to estate taxation have been two-fold; 1) to tax estates which never would have been subject to the estate tax in 1942 (i.e., those with less than $60,000 in assets-which today would en- compass those with less than $210,504 in assets) and 2) to tax eligible estates, regardless of size, at a greater rate than would have resulted for the same estate value in 1942. An increasing number of estates have become subject to the estate tax over the years. This effect is demonstrated in Table 5. NUMBER OF ESTATE TAX RETURNS FILED BY CITIZENS AND RESIDENT ALIENS IN RELATION TO TOTAL DEATHS Total Taxable RatiO of- Total. Taxable Year returns filed returns filed Deaths 1 returns to deaths returns to deaths 1941 1951 1961 1970 1973 15, 977 27,958 64, 538 133,944 174, 889 13, 336 18,941 45,439 93,424 120, 761 1, 432, 000 1,468,000 1,708, 000 1,926,000 1,962, 000 1. 1 1.9 3.8 7.0 8.9 0. 9 1.3 2. 7 4.9 6. 2 1 In preceding year. Source: Statistics of income: Estate tax returns, 1965, 1969, and 1972; Statistical" Abstract of the United States, 1973." This Indicates that in 1942, there were 1,432,000 deaths with 12,336 taxable returns filed, or less than 1 percent. In 1972, there were 1,962,000 deaths, with 120,761 taxable returns filed, or 6.2 percent. Expressed in other terms, in 1941, less than one estate out of 100 required a federal estate tax, compared with over 6 out of every 100 estates in 1972. As stated earlier, the estate tax is dipping down into smaller estates (as meas- ured by purchasing power) than it did In 1941. Had the Congress at that time in- tended to tax estates at the effective rate at which comparable values are presently taxed, the exemption would have approximated only $17,100, and the 77% maximum marginal tax rate would have become effective at roughly $3 mu- PAGENO="0422" -4 a >0 C,, © 00 -400 (~ ~ C)C)N)N)'-~ - - ~ ~88 ~ ~ ~-000~ N)C~ ~ )r%)a, co~ ~ ~ cjo~cj~ ~ ~N) 00 ~N)00~ N)~ 000Q~ C) N)o-'000)1 ~ C) ~ N)o-~ C~ 0) ~ CoO CoO N) 0000 N) N)N)N)N)r%) N) ~N)ro~~oO N)-oO~oO'oO U1~ 00 ~ C)~ - Cii ~ ~ (04Ø) C)iCoON)N)~° ~ C0N)Cii OOo°00 ~ 00Ci~ (ii~ 00 N) Co CO N)rCoN)~-~ 0) 00~N)Q0 ~ ~ ~N)COt0)(0 © ©~ ©Q0)00~ ~-J ~-J ~ c~ U' Ui~ ~ COOCOOCO) CoO CoO N)N)N)~- -- ~.J 00(o) © -JCoO 000) CoO OCiON) 10-1 UI N) ~ 00U)N)00 ~ 4CoO ~O~~J~o)-J ~J0) JC000(o) Ui~o) N)Q~~Co CO C > 0~ >-4 -I -4-4 >> 00 -I,> C,, -4-4 >~ XC > C) 00 I,, C~) C,) - -4 >00 -4 rn ~ > 0 CD - 0~0. ~ ~ rj~ ~ ~ ~ ~CD~ ~ ~CD CDCD 4-so: 01 C-'- B: C-'- C-,- 01 QCD 01 -4 -4 N) >00 PAGENO="0423" 409 that dollar value bracket is now $70,200 to $105,200, and is taxed at a marginal rate of 28 percent-a 100 percent increase In the marginal tax rate at a relatively low estate value. Phe span of estate tax values included In the progressive rate structure also has been effectively reduced-since the maximum marginal tax rate of 77 percent would he applied to the taxable estate in excess of $3 mil- lion, as opposed to the $10 million estate value originally established by the Congress. S In the interest of returning parity to the estate tax structure, NAW recommends the Congress revise the tax brackets to reflect present day values. Tables 7 and 8 present an analysis of the effects of inflation on various sizes of wholesale distribution firms passed on to the next generation. TABLE 7.-~-AVERAGE WHOLESALE-DISTRIBUTION FIRM BY ASSET SIZE: ASSETS AND NET INCOME AFTER TAX Asset size $100,000 to $250,000 $250,000 to $500,000 $500,000 to - $1,000,000 $1,000,000 to $5,000,000 Number of returns 38,718 23,562 14,810 11,082 Total assets (thousands) Average asset per firm Total net income after tax (thousands) Average net income after tax per firm $6, 352, 185 164, 100 434, 750 11, 228 $8, 348, 339 354, 300 471, 491 20, 010 $10, 374, 151 700, 500 517, 961 34, 975 $21, 189, 452 1,920, 600 935, 533 84, 419 Source: Corporation Source Book of Statistics of Income, 1971; p. 15. TABLE 8.-IMPACT OF ESTATE TAXES ON TYPICAL WHOLESALE~DISTRIBUTION FIRM BY ASSET SIZE CLASS Asset size $100,000 to $250,000 $250,000 to $500,000 $500,000 to $1,000,000 $1,000,000 to $5,000,000 Average asset $164,100 Less exemption 60,000 Taxable estate 104, 100 Estate tax 21,930 Net income after tax 11,228 Ratio of estate tax liability to asset earnings_~ 1. 95 $354,300 60,000 $700,500 60,000 $1,920,600 60,000 294,300 79,876 20,010 640, 500 195,050 34, 975 1, 860, 600 691, 100 84,419 4. 00 5. 58 8. 18 Source: Derived from table 7 and applicable estate tax rates (guide to Federal estate and gift taxation). The heirs of a family-owned distribution firm will naturally look to the business to pay the estate taxes attributable to the business. In our example above, we have considered the business asset as representing the entire estate (this allows for the application of the $60,000 and the lowest possible rate ccf estate taxation). It must be noted that any additional asseta in the estate would be taxed at a significantly higher marginal estate tax rates. Table 7 shows the average asset size and net Income for wholesale distribution firms in the $100,000 to $250,00, $250,000 to $500,000, $500,000 to $1 million and $1 to $5 million asset groupings as derived from the `Statistics of Income Series, 1971, the latest year for which data is available. The comparable data for 1970 sl~ows essentially the same figures for firm size and net income. The typical firms in the four asset classes have assets of $164,100, $354,300, $700,500 and $1,920,600 respectively. Should the chief executive officer and owner die, the heirs would `be faced with estate tax burdens on these relatively modest sized firms that ranged from roughly 2 to 8 times the annual net income of the firm. The estate tax burden and the liability of the heirs and the executor of the estate to pay this tax threatens the continped existence of the business. The typical firm in the $250-$500,000 aset category has $354,300 in assets which would represent a $294,300 taxable estate with estate taxes due of $79,876 and an earning capacity of only $20,010. In the next asset category, $500,000 to $1 million, the average firm had $`t00,500 in assets which represented a taxable estate of $640,500, and an estate tax of $195,050-an amount five and one half times the annual earnings. Even if the estate tax was to be paid over a 10 year period, the taxes in the first year would be $33,158,1 while the earnings of this firm were 1 Calculated on 10 percent of principal plus 7 percent interest. PAGENO="0424" 410 shown to be only $34,975. No business can survive in a climate in which estate tax payments seize 95 percent of the income. Clearly, inflation and the rate structure of the estate tax have had a tremendous adverse Impact over the years, but most specifically, this impact has been felt to a greater degree by the relatively small estate. In the words of Senator Gaylord Nelson, "the steep graduation In the estate tax, on top of a completely outdated exemption, is pushing most businesses and farms into a danger zone where estate and inheritance tax brackets make retention of the business or farm impossible." We have illustrated the tremendous tax liabilities which fall due upon the death of a principal owner of a small, closely-held business. However, this prob- lem is compounded when one considers the nature and liquidity of the assets which comprise the estate consisting mainly of an interest in a closely-held business. Closely-held stock is highly illiquld, as there is not a ready market for the stock and such stock is not easily saleable. In addition, it is highly unlikely that a prospective buyer of closely-held stock would be interested in obtaining only a minority interest in the firm, thereby allowing the heirs of the estate to continue control of the family interest in the business. One must also consider the tremendous problems encountered in valuation of the closely-held stock, as there are no truly objective standards employed in the IRS valuation of the closely-held business for estate tax purposes. The preceding discussion clearly demonstrates the problems which face the small, closely-held business upon the death of a principal owner. The future of that business can be very directly affected by the ability of the heirs to pay the estate tax. Inability to generate a sufficient amount of cash to satisfy the estate tax liabilities may force the heirs to sell their interest in the closely-held business for this purpose. It must be understood that the closely-held business which has lost its principal owner Is in a precarious position already, notwithstanding the additional burden of estate taxes. A difficult transition period takes place, during which time the lndivduals (s) charged with directing the business must seek to compensate for the loss of valuable management skill and leadership which the principal owner had furnished over the years. Customers and suppliers must be assured that the business will continue to provide goods and services in an efficient manner, that existing financial obligations will not be neglected for any reason, and that future profitabilty will not be adversely hampered. The problems and concerns of the closely-held business stated above are by no means all-inclusive. The fact remains that the closely-held business will face a period of uncertainty, and remain particularly vulnerable to a variety of situations, when faced with the death of a principal owner, who was most likely the chief executive officer. At the same time, however, the heirs of the business must also be concerned with the payment of estate taxes. When the estate consists largely of an interest In a closely-held business, the heirs have few options open to `them with regard to payment of the estate tax: pay with cash on hand (usually not a viable option), pay with cash obtained through a loan, pay on an extended basis in yearly in- stallments, or pay with cash obtained through sale or merger of the firm. Extension of additional credit at this time is highly questionable. Indeed, the contrary is likely to happen as the principal owner is also the chief executive officer, the one looked to by the bank to manage the business in such a way that the bank will be repaid its already outstanding loans to the closely-held business. When the closely-held business loses its OEO (usually the president), the bank is very likely to recall a portion of the loan or decline to extend addi- tional credit or renew current loans until the future of the business is more certain. LIBERALIZATION OF TIME ALLOWED FOR PAYMENT OF ESTATE TAXES We have repeatedly emphasized the problems which face a closely-held busi- ness upon the death of a principal owner, including the inability of the closely- held business to easily convert assets to cash in order to pay the estate tax due to the illiquidity of those assets. It must be remembered that estate planning- even the most diligent-is difficult. Regardless of the effort spent in prior plan- ning, the most important determinant remains unknown-the time when death will in fact occur. Therefore, the sooner the heirs of the estate are required to pay the estate tax, the more pressing the problem of liquidity-or the lack of liquidity-becomes. PAGENO="0425" 411 Prior to 1970, the IRS allowed 15 months from the date of death for the filing and payment of the estate tax. Thjs period was reduced to 9 months in 1971, largely to provide a one-shot revenue increase necessary to pump funds into the budget for the next year. At that time, NAW testified in opposition to this reduction, but suggested that if the revenue needs were pressing, the establishment of a 12 month period for filing would appear to be more equitable and realistic. To quote our earlier statement (Hearings Before the Committee on Ways and Means On The Subject of Tax Recommendations of the President, page 285), "Treasury policy need not be tailored to push to the wall these people who inherit ownership of smaller business enterprises during their time of painful transition." We would like to reiterate that position at this time, and recommend the Committee increase the time allowed for filing and payment of estate taxes to at least one year. Additionally, every effort should be made by the Congress to allow the closely- held business the maximum amount of time possible for full payment of the estate tax. To do otherwise would effectively signal the demise of many of these closely-held businesses. SECTION 6166-ExTENSION OF TIME ron PAYMENT IN TIlE CASE OF A CLOSELY-HELD BUSINESS ~1n the case of an estate consisting largely of an interest in a closely-held business (i.e., where such an interest comprises 35 percent of the value of the gross estate or 50 percent of the taxable estate), the executor of the estate may elect to pay that portion of the estate tax attributable to the business interest in not more than ten years, with payment on a yearly basis. The Code defines closely-held business as: a) a proprietorship, b) a partnership having no more than 10 partners or one in which the business interest is at least 20 percent; or c) a corporation having no more than 10 shareholders or one in which the decedent held at least 20 percent of the voting stock. This option has been Included in the tax code in an effort to provide a measure of relief and protection to the closely-held business. In practice, such provisions which grant an extension of time for payment of taxes are largely ineffective, mainly because of the stringent criteria set down in the Code. NAW firmly believes the effectinevess of Section 6166 would be greatly enhanced if the requirements were eased-by increasing the allowable number of shareholders from the present 10 to 15 and reducing the percentage requirements for the decedent's interest in the closely-held business from the present 35 percent of gross estate or 50 percent of taxable estate to 20 percent of gross estate or 35 percent of taxable estate. In this regard, one must also consider the impact of Employee Stock Ownership Plans (ESOPs) on the ability of the closely-held firm to elect to pay that portion of the decedent's estate tax attributable to the business interest In installments. The Congress has, on many occasions, endorsed the concept and utilization of ESOPs. However, if the closely-held business determines that an ESOP should be established within that firm, the resulting increase in the closely-held business' number of shareholders (and decrease in the percent of voting stock held by the previous shareholders) could prohibit that firm from paying the tax in install- ments upon the death of a principal owner. The decision to establish an ESOP within a closely-held business may therefore be tempered by considerations of the estate tax consequences. SECTION 6161-EXTENsION OF TIME FOE UNDUE HARDSHIP OR REASONABLE CAUSE Another section of the Code provides for an extension of time upon determina- tion by the IRS district office of "undue hardship" or "reasonable cause". Such determinations are, in the words of the Code, "discretionary with the appropriate internal revenue officer and his authority will be exercised under such conditions as he may deem advisable." Undue hardship is defined as "more than an incon- venience to the estate". A granting of undue hardship allows the estate to pay the tax over a specified number of years, not to exceed 10 years. If reasonable cause can be shown, the district IRS office may .grant an extension of not more than 12 months for payment. Reasonable cause is generally thought to exist when assets necessary for payment of the estate tax are not readily available or will be received in the near future. In both cases, the executor of the estate remains personally liable for the payment of the full amount of the tax. PAGENO="0426" 412 Unfortunately, statistics on the number of estates requesting and receiving any type of extension of time for payment of estate taxes are extremely lacking. It has been estimated, however, that on1~ 1% of the estate tax returns filed in 1972 requested an undue hardship extension.2 There is no information on how many of these requests were granted. Despite the lack of statistics in this' area, a review of the literature and testimony available in the estate tax area reveals that little use is made of these provisions for a variety of reasons-mainly, the harsh requirement that the executor of the estate remain personally liable for the full amount of the tax and the discretionary nature of the determination of undue hardship and reasonable cause. It has been proposed that the existing Section 6161 be liberalized to allow broader use of this option. Senator Walter Mondale, upon introduction of S. 2394 on `September 23, 1975, stated: "Our estate and gift tax laws are intended in part to prevent excessive con- centrations of wealth. Yet in their application to small `businesses and family farms, they may be inadvertently increasing it . . . making the installment pay- ment provisions easier to use could well ease the liquidity problems faced by many family farms and businesses, and make it unnecessary to sell the farm or business to pay the estate tax . . . the present requirement of "undue hardship" can be a difficult one to meet, and permitting Installment payments in any case of simple hardship would make the installment payment option more broadly available." NAW strongly recommends that the Committee adopt this type of provision, by striking out the word "undue" from section 6161 of the Internal Revenue Code. We have detailed earlier in our statement (pages 20-21) the impact of estate taxes on a typical closely-held wholesale distribution firm, even with an extension of time for payment of 10 years. The example concluded that serious doubts would remain as to whether this typical closely-held wholesale distribution firm could survive in its present form. Accordingly, NAW recommends that the present 10 year maximum repayment period allowable under both Section 6161 and Section 6166 of the IR'C be increased to 15 years. The enactment of liberalized provisions for payment of estate taxes attributa- ble to an interest in a closely-held business would do much to enhance the per- petuation prospects of those businesses. Further, the revenue considerations involved in any liberalization of payment of these taxes would be small. Payment in full-plus interest-will be made; we are not advocating a forgiveness of any portion of the tax. Additionally, we observe that many legislative proposals dealing with estate tax reform also would provide for an increase in the marital deduction. While NAW endorses an increase in the marital deduction, we would like to emphasize the fact that it would in no way solve the long-term problem of perpetuating a family-type, closely-held `business from one generation to the next. Our support for an increase in the marital deduction is therefore tempered by reality-the harsh reality that the increased marital deduction, which needed, in no way solves the basic problem of continuing family-type enterprises under a highly progressive estate tax system. IMPOSITION OF CAPITAL GAINS TAX ON ASSETS TRANSFERRED AT DEATH We note that some tax reform proposals `before the Congress would contem- plate an entirely different approach to tax reform-the imposition of a capital gains tax on assets transferred at death. Such a tax would sound the death knell for small businesses such as those engaged in wholesale distribution. Those who favor such a tax argue that unrealized appreciation of capital as- sets, regardless of kind, is income which currently escapes taxation when held until death. They maintain that this unrealized capital gain Should be taxed as If it had been sold the day before death. We are confident that this Committee will recognize the dangers of such a form of taxation to the small, closely-held business enterprise. To the typical small wholesale distribution firm, a tax on capital gains transferred at death, coupled with existing high estate taxes due, would most probably preclude the perpetua- tion of the business. We therefore urge the Committee not to apply a capital gains tax to an imaginary gain. Taxation of a gain founded only on the assumption that it has in fact occurred is not a realistic basis for taxation. 2 CongressIonal Record, September 23, 1975, remarks of Senator Walter Mondale. PAGENO="0427" 413 Mr. BtTRLESON. The committee will stand adjourned until 9:30 in the morning. Oh, we may have one more witness. I didn't understand. Is Mr. Hildreth here in the audience? Mr. HILDRETH. Yes, sir. Mr. BURLESON. I apologize. Mr. HJLDRETH. I almost had to leave. Mr. B1IRLESON. Well, we will be glad to hear you. You represent the Maine Audubon Society. We are most pleased to have you with us. STATEMENT OP HORACE HILDRETH, STATE OP MAINE AUDUBON SOCIETY Mr. HILDRETH. Thank you, Mr. Chairman. I will just take a minute. You have had a long day and I have a plane to catch, and the only reason I didnt' really run when I had the opportunity just now is be- cause I noticed that you have very few environmental groups appear- ing during the course of the week, and I am here representing a number of environmental organizations, including the Maine Audubon So- ciety, the National Resources Councit of the State of Maine, the Maine Coast Heritage Trust, State Biologists Association and also a couple of groups from Massachusetts, the Massachusetts Audubon Society and the Conservation Law Foundation, which is headquartered in Boston. I didn't notice any other environmental groups, and I simply wanted to express our interest in the subject of these hearings, as distinguished from the interest of farming and small business organizations and to try and boil it down as much as I can. I think our interest is in the potential use of an alternate method for valuing real estate, which is being used for farming, for productive woodland, or is being reserved as open space or has some kind of his- toric cultural importance. We see too many situations in which the use- fulness of this kind of land is being literally destroyed, or the major value of this kindof land is being literally destroyed, because of the pressure of the Federal estate tax in certain situations. Although the land continues to exist in these cases, it no longer ex- ists as farmland or as a productive wood~lot, and too often in areas near growing cities the loss to society is one that cannot be measured simply in tax dollars as accurately as Mr. Vanik or Mr. Oonable were hoping for this morning. I do appreciate your patience and your willingess to take such a long day, and it was certainly very interesting for me to be here. Mr. BURLESON. Well, your complete statement will be included in the record. Mr. HILORETH. Yes, thank you. Mr. BURLE5ON. Without objection. [The prepared statement follows:] STATEMENT OF Ho1i.~cE A. HILDEETH, JR., REPRESENTING THE GOVERNOR OF MAINE AND THE MAINE AUDUBON Socinr~ Mr. Chairman, members of the eommittee, my name is Horace A. Huldreth, Jr. I reside In Falmouth, Maine. I am here representing the Governor of the State of Maine, the Maine Audubon Society, the Natural Resources Council of Maine, the Maine Coast Heritage Trust, and the State Biologists' Association. I estimate that these organizations In the aggregate represent some 15,000 people which is a large number when you are talking about the State of Maine. In addition to these, PAGENO="0428" 414 and in the interest of saving the time of this Committee, I am here on behalf of two other environmental groups from the Commonwealth of Massachusetts: the Massachusetts Audubon Society, and the Conservation Law Foundation of New England which is headquartered in Boston. With your permission these organizations are submitting their own written statements to you which, if I understood the rules of the Committee correctly, should reach you by Friday of this week. I am here to speak principally in behalf of the concept embodied in H.R. 1793 and H.R. 3832 both of which would amend the Federal Estate Tax Law to take a more discerning and intelligent approach to taxing real property on the death of a decedent. All of you must be aware, as are many of your constituents, that the Federal Estate Tax Law, because of the failure to have changed it over the years to respond to changing sociological conditions, is seemingly bent on the destruction of all productive or useful or historically important land which is located in proximity to urban areas. One wonders why it has taken the Congress so long, and we commend you for starting, to rebuild the Federal Estate Tax Law to put it back in a posture which must have been more nearly Intended by the drafters more than forty years ago. Certainly they could not have intended or foreseen the consequences that recent Congresses have allowed to occur. I am referring to the unconscionably low exemption of $60,000, and the pain- fully obvious need to provide an alternative method for valuing real estate which Is being used for farming, for productive woodland, or is being reserved as open space or has historic and cultural importance. As spokesman for the Governor of the State of Maine and the various groups which I have mentioned, I have come to Washington at my own expense to commend you for initiating hearings on this subject and to plead with you to convince the Congress to spmmon the courage and wisdom to overcome the inertia of the past decade during which the need for this kind of legislation has become agonizingly apparent, and act. The concept behind the two bills which I have seen, H.R. 1793 and H.R. 3832, is one which deserves the attention of any Congressman who represents a district in which population has been or will continue to grow. I will not dwell upon the impact of the present form of the Federal Estate Tax Law upon farming communities and farming families and on farms in general in the State of Maine other than to say that although their destruction is less wholesale and immediate in Maine than it is in many other areas of the United States, it is nonethless apparent that the death tax is becoming their death knell. But because you will be hearing from numerous farm groups during the week, I shall briefly confine myself instead to that aspect of the two House Bills which deal with woodlands and land reserved for open space purposes. I am sure you know that many states, and I believe the first of these was Maryland, are beginning to understand that real property taxes are destructive when imposed mindlessly and without discrimination upon all land calling for a valuation based upon its highest and best use. The states have l~egun to under- stand, and Maine is one of them, that a given parcel of land, being inherently unique, may well be too valuable, too culturally or socially Important, or too specifically productive or useful to be treated on the same footing as all other land which may not have these qualities. These states have lead the Congress In providing means to take the state property tax heat off these kinds of land. I am sure that each of these states needs the tax revenue as badly as the United States Treasury Department feels it needs the revenue which is presently derived from the Federal Estate Tax. Nevertheless these states have seen the wisdom in foregoing short-term tax gains in exchange for long~term benefits to their people. I would urge you to recommend the same wisdom to the Congress. The Federal Estate Tax raises comparatively little revenue compared to the Federal Income Tax, yet all too often its imposition simply on the basis of the highest and best use of land makes it become confiscatory. Its impact is magnified all out of proportion to what it was intended to accomplish. Land of the type these bills seek to protect, must continue in their current use in order to escape the full brunt of the tax. The period for which use must continue seems to vary between hills but might be required to last for ten years after the death of the decedent or even for the remaining lifetime of the heir. We have no objection to the stiff recapture provisions that have been suggested in these bills. They must be made formidable to be effective, and I believe these bills succeed In doing this. PAGENO="0429" 415 I was disappointed not to see in any of the bills I have read, and I am sure there are some I have not seen, a way in which the heir could in fact sell the land for which the election had been made without incurring the recapture penalty, provided that the purchaser became subject to the penalty upon a change of use. I fail to see how this would give the heir a windfall since theoretically, at least, he would not be getting a highest and best use price, but only a current use price. In any event, I and the groups I am representing are most appreciative of the fact that you are at least examining these problems, and have allowed us to appear and exhort you to acknowledge and try to solve them. STATE OF MAINE, OFFICE OF THE GOVERNOR, Augusta, Maine, March'10, 1976. Hon. AL ULLMAN, Chairman, House Committee on Ways and Means, House Office Building, Washington, D.C. DEAR REPRESENTATIVE ULLMAN: I commend the Ways and Means for scheduling hearings on HR 1793 and HR 3832 because the subject to which they are addressed is of vital importance to the State of Maine as I am sure It must be to many other states as well. We are realizing in Maine that productive farms are Important assets to preserve and encourage. We need also to stabilize food prices and supplies. But all too often we have seen the breaking up of active family farms because of the impact of death taxes. The concept behind these bills is a sound one. It recognizes the importance of giving a reasonable protection to farms, open space and woodlands but still requires the owners maintain the existing and usually productive use of the land. Even though Maine is not yet a highly urbanized State as most other states in the northeast, we feel that the legislation considered here will be of Immense practical value to us. Sincerely, JAMES B. LONGLEY, Governor. Mr. BURLESON. Well, I appreciate very much your being here. If you get all the environmentalists behind this legislation, I think we can pass it. They seem to be pretty influential around here. Mr. Duncan. Mr. DUNCAN. I have no questions, other than to thank you for your patience in waiting on us. We usually save the best for the last anyway. Mr. HILDRETH. You are very kind. Mr. BURLESON. Mr. Pickle, do you have a question? Mr. PICKLE. No, thank you, Mr. Chairman. Mr. BURLESON. Mr. Steiger. Mr. STErnER. No. Mr. BURLESON. Again I apologize for having overlooked you~ Now the committee will stand adjourned until 9:30 in the morning. [Whereupon, at 5:57 p.m., the committee adjourned, to reconvene at 9 :30 a.m., Tuesday, March 16, 1976.] PAGENO="0430" PAGENO="0431" FEDERAL ESTATE AND GIFT TAXES TUESDAY, MARCH 16, 1976 HOUSE OF REPRESENTATIVES, C0MMITrEE ON WAYS AND MEANS, Wa8hington, D.C. The committee met at 9:30 a.m., pursuant to notice, in the com- mittee hearing room, Longworth House Office Building, Hon. Al Uliman (chairman of the committee) presiding. The CHAIRMAN. The committee will be in order. We are very pleased to have as our leadoff witnesses this morning two of our very distinguished colleagues from the other side of the show, Senator Gaylord Nelson from Wisconsin and Senator Bob Packwood of the State of Oregon. Senators, we will be very pleased to have you take the witness table and we look forward to hearing your views on this very im- portant matter of gift and estate taxes that we have before the committee. Senator Nelson, do you want to lead off. STATEMENT OP HON. GAYLORD NELSON, A U.S. SENATOR PROM THE STATE OP WISCONSIN Senator NELSON. Thank you, Mr. Chairman and members of the committee. Senator Packwood and I are addressing ourselves exclusively to the question of estate taxes and, in order to avoid as much as possible being repetitious and thus unnecessarily imposing upon the time of the committee, I would ask that my statement, with some attending charts and so forth, be printed in the record so that I can avoid going into great detail on this. Last December Senator Packwood and I introduced a bill called S. 2819, and in the House it was introduced as H.R. 11484, I believe. They are the same bill. The committee took testimony yesterday on that bill, so that I shall not repeat a discussion of that bill that was introduced in December because you have a record on it based on yesterday's testimony. I will simply submit a statement that covers most aspects of that bill. The question, I think, that we face is: Should we attempt, by use of the tax system, to preserve the opportunities for independent small enterprise to survive and thrive and pass that estate on without having to break up the farm or the estate in order to pay the taxes? If that question were resolved in the affirmative, then the question would be: What is the best way to do it from the tax standpoint? (417) PAGENO="0432" 418 I come down on the affirmative side. Others do not. But having come down on the affirmative side, what estate tax proposal is the most equitable one? We all know that the $60,000 estate tax exemp- tion was established, I think, in 1942. The argument that this com- mittee has heard and that we heard in the Small Business Com- mittee in our hearings last fall, wa~ that the farmers and small businessmen would like and desire, and think it is only fair, that that estate tax exemption be increased to the equivalent dollar value of what it was then. The bill that Senator Packwood and I put in and that others on our side put in who are now in the Finance Committee and will be awaiting consideration after your committee deals with the question all dealt with the question of raising the exemption. I am not expert in the tax field and, the more I look at the ques- tion, I can see that the more complicated it gets. But after looking at it and evaluating it for some time and having staff people and other experts look at it, I have concluded, as has Senator Packwood, that if we are going to do something about the estate tax exemption, it would be better, more equitable and would better preserve the progressivity of the system to have a tax credit rather than to increase the estate tax exemption, which would benefit the larger estates more heavily. In other words, the higher the tax bracket, the greater the benefit is from any given exemption level, so raising the exemption would give a larger tax break the larger the size of the estate, whereas, if you establish a tax credit in place of the exemption, and apply the tax relief in that way, then the larger estates do not get a progressively greater benefit. Yesterday Senator Packwood and I put in two bills, bills that we both cosponsored, dealing with estate tax relief from the tax credit approach. I don't want to read all these statistics but, for example, according to the statistics developed by staff, if you were going to desire to do the same thing the President did-that is, to increase the exemption level to $150,000, the same size of tax-free net estate would be achieved through the tax credit approach with a credit of $35,700. In other words, if you were going to match what the President proposed, it would require a $35,700 credit to completely eliminate the tax liability on all estates up to a net size of $150,000. On the Treasury cost end, if you took the President's proposal, the Treasury estimate, projected by our staff, up to a 1977 basis is that increasing the tax exemption as such up to $150,000 would cost the Treasury $1,900 million. If you achieved the same purpose for the smaller estates by a $35,000 credit, the cost would be $1,100 million. So that there is an $800 million saving. I think the credit approach is clearly much better, no matter what level of tax-free estate one wanted to achieve, because whatever the level, the credit costs less than the equivalent exemption, and it does not benefit the larger estates more than the smaller estates, as the direct exemption does, whatever its level. For example, if you wanted to go to a $131,000 exemption, the cost would be $1,500 million. But the same level of tax-free net estate would be achieved by a $30,000 credit, at a cost of only $840 million. So that in each case, raising the exemption directly is a much PAGENO="0433" 419 more costly way of providing the desired tax relief, and, from the standpoint of not eroding the progressivity of the rate structure, I think it is clear that the credit provision is better than the fiat increase in the exemption. Basically that is what we are suggesting for consideration of the committee. I am quite aware that, with the expertise on this committee as well as on the staff, any proposal we make can be refined and im- proved substantially and we would like only to have your evaluation of the credit concept so that we will have the benefit of the thinking of this committee and your staff when it arrives over at the Finance Committee, of which Senator Packwood and I are both members. I did ask that my statement and charts be printed in the record. The CHAIRMAN. Without objection the full statement will appear in the record. [The statement and attachments follow:] STATEMENT OF HON. GAYLORD NELSON, A U.S. SENATOR FROM THE STATE OF WISCONSIN Mr. Chairman, Members of the Committee, we appreciate this opportunity to present our suggestions on estate and gift tax revision for the Committee's consideration. During. 1975, the Senate Small Business Committee devoted 2 full days of hearings and substantial time in three field hearings to this subject. As a result, in December, we Introduced a Small Business Estate and Gift Tax Reform bill (5. 2819 in the Senate, and H.R. 11484, H.R. 11496 and H.R. 12100 in the House). The President also made two proposals In this area, In January and in March, and there are a number of different bills pending before this Committee and the Senate Finance Committee. Since the House acts first in tax matters, we wished to give the Committee the opportunity of evaluating the suggestions emerging from our~ study. The fact that the estate and gift tax laws have not been revised since 1942, and inflation has increased prices by 289.39~, since then (according to the Joint Economic Committee) constitutes a particular problem for family enterprises. In human terms, it has made the death taxes a problem to average farmers and small business owners, not just the enormously successful ones. It seems that many farms and businesses must be sold to pay the taxes, rather than keeping these units in the family, as the owners and their children might wish. The ecoii~mic consequences to all our cltizen~ Is that family farms and small enterprises are often the most efficient, competitive, and innovative producers. Their elimination makes us more dependent on bigger, Impersonal and often less-competitive conglomerates with few if any royalties to their localities. The ultimate question posed by estate tax policy Is whether the country wishes to preserve a climate where family enterprise can survive a transfer from one generation to another, or whether we are going to destroy most exist- ing family firms and weaken the incentive to establish new ones by continuing the present limitations. THE FARM SITUATION Let me Illustrate the problem In concrete terms. In rural areas many farmers bought their land 30 or 40 years ago for $100 an acre. Now, productive farm land sells for over a thousand dollars an acre In 6 states and' is approaching that level In 4 others. The average value of farms in the U.S. has risen from $51,000 in 1960 to $170,000 in 1974 and has accelerated most rapidly In recent years. We have attached a chart of farm land values In each state which re- flects this. Including the family's bank account, insurance, and personal prop- erty, the Mr. Average Farmer's estate will thus be over $200,000. He has worked hard and borrowed much to accumulate his land, buildings, equipment, and what little cash he has. He has taken the risks of the weather, the market, and the general economy over the years. Many farmers are not aware of what the outdated estate tax will do to them. A January 1976 survey of 600 Farmers' Union officers In Wisconsin disclosed that only about half had wills and only one-third were aware of the potential Federal estate taxes that would have to be paid. 68-872 0 - 76 - 28 PAGENO="0434" 420 Another study in Iowa of 76 farmers revealed that 91 percent of them would not have enough liquid assets to pay the Federal and state death taxes. The Senate Small Business Committee heard testimony in 1975 that about a third of the farms in the Northwest are being sold to pay estate and inheritance taxes. SMALL BUSINESS HAS SIMILAR ESTATE TAX PROBLEMS The nature of a small machine shop or distribution firm or other small busi- ness is that, typically, the earnings are plowed back into the business. Over a lifetinie of long hours and repaying bank loans, family and closely held com- panies may have accumulated modest estates worth several hundred thousand dollars. The estate tax rate on $100,000 is 30%. If the business is a corporation, there are other options beyond sale to raise the money. If the owners can find a big corporation interested in buying them out, they can exchange his stock tax free for the big company's stock. Before the recession of 1974-75, there were 4,000 to 6,000 mergers a year. IMPACT ON INDUSTRIAL STRUCTURE A sale or exchange of stock will solve the farmers or businessman's financial problem .The ultimate results to our economy over the years of such attrition are dismal. First, entrepreneurs who built up their businesses through a lifetime of effort find that death taxes place it beyond their reach to transfer their prop- erty to their children. Second, the costs of establishing a new farm-presently estimated at between $200,000 and $250,000-are already a potent factor in keeping younger people out of agriculture. The Federal tax policy is prevent- ing the continuation of farms and small businesses which are now in family ownership and increasing entry costs are discouraging new people coming in. Thus, for a generation, the Federal law has beeii an increasing force in shift- ing ownership of productive assets to larger and larger units. This has been changing the character of our economy and our society, in my view, for the worse. COMMITTEE RECOMMENDATIONS Accordingly, on the basis of the Small Business Conunittee's year-long in- vestigation, we submit the following recommendations for the Committee's consideration: 1. Estate Taa~ The Congress of 1976 should restore the effect of the estate tax exemption to approximately what the Congress of 1942 envisaged. It appeared to be the Congressional intent in the past that a person could pass on his home, car, personal property, and a substantial amount of his busi- ness property free of tax. Today, many residences would absorb the total amount of the exemption alone. To leave the present limitations unchanged substantially changes the intent of the law. The inflation factor alone would indicate an increase to about $173,580.1 The revenue cost of doing this would be about $2.1 billion using an exemption (on a fiscal year 1977 basis) or $1.5 billion using an estate tax credit. The Committee's Print summarizes the various bills for increasing the exemption. My own bill recommends an estate tax exemption of $120,000; or $180,000 with the combined use of an increased gift tax exemption. THE CREDIT MECHANISM Our further study of these problems had led us to introduce legislation offering to substitute a credit for the exemption mechanism. This has the dis- tinct advantage of being able to provide the same relief for much less. For example, the President's proposal for an exemption of $150,000 might cost about $1.9 billion. An equivalent $35,000 credit would cost $1.1 billion. A $30,000 credit, which we are suggesting, would involve $840,000 million (FY `77 basis). The credit would also be more equitable for small and medium-sized estates. The favorable experience with the individual income tax credit in 1975 bears this out. We therefore believe that a credit would be preferable for ac- 1 The personal income tax exemption has been increased 50% (from $500 to $750). PAGENO="0435" 421 complishing this relief. We will submit a chart showing the revenue effects of exemptions and equivalent credits to various levels, and hope that the Com- mittee might wish to evaluate this alternative. 2. Gift Taco We recommend that there be a comparable adjustment in the gift tax. Chang- ing only the estate tax would do nothing to restore the alternative of a life- time disposition of a farm or business while the older generation is still around to help with the transition. We feel it would be most desirable to again make this an effective alternative to greater consolidation, merger, and conglomerate control of business prop- erty. Among the many possibilities, S. 2819 approaches this by making the increased estate tax exehiption usable also for lifetime gifts. THE MARITAL DEDUCTION 3. Relief for ~Surviving Wife Providing for the welfare of a surviving spouse Is a problem of urgency equal to providing for transfer to the next generation. This is especially critical for a wife who has helped in the business but not contributed "money or money's worth" to its growth. Our bill approaches this by increasing the marital deduction to allow transfer of enough tax-free assets for her to live on (perlljlps $240,000 to $250,000, as suggested in S. 2819~). Revenue loss from such relief can be minimized by phasing the marital deduction down or out at an appropriate level. DEFERRAL OR STRETCH-OUT PROVISIONS 4. f~trengthen Deferral Provisions Revise the present deferral sections of the Internal Revenue Code (Sec. 6166 and 303) along the lines suggested in S. 2819, so as to make this again an extension up to 10 years a practical possibility. At present, most deferrals are stymied by placing personal liability upon the executor for payment~ of the deferred tax. 5. 2819 recommended that this be changed to a lien on the assets of the farm or business of 150% of the tax deferred. Also In th area of deferral, we would suggest the Committee also consider, in lieu of the President's proposal, stretching out the deferral period to 15 years, and allowing the new owner to pay interest only for a period of 3 years. The interest rate would be at the cost of money to the Federal government plus 4~ of 1%, a rate already used for many loans under the Small Business Act. VALUATION PROBLEMS 5. Valuation 5. 2819 provIdes an alternative to so-called "use valuation," in dealing with the problems of farms near expanding cities. Our suggestion is to permit the farmer or small businessman to restrict the use of the farm by an enforceable covenant which could be valued actuarially. This could avoid the problems of recapture and future adnilnistratlon connected with "use valuation." 6. Direct a Treasury study on the implications of mergers Induced by death taxes, and their social and economic consequences, including concentration of wealth, absentee ownership, and their implications to business, cities, and smaller towns across the country. CONTRIBUTION OF SMALL BUSINESS TO THE NATION The new, family, local, small, and independent business community is of great value to this nation. It provides 52% of all private employment, 43% of the business output, 1/3 of the Gross National Product, and over half of all innovation, Including major industrial changes in petroleum refining, alum- inum manufacture, copying and computer miniaturization. Beyond the statistics, however, the worth of small and family enterprises to our national life Is immeasurable. Studies have proved that locally owned business are stronger supporters of local, social, and charitable institutions In the cities and towns where the owners reside and have their roots. Self-reliance in economics goes hand in hand with Independence of thot~ght and action, the foundation of our demo- cratic form of government, as Thomas Jefferson perceived 200 years ago. PAGENO="0436" a a a. Co c,~ ~CI2 ~Q ~. ~ ~ a E ~- th~ E a ~ - ~ O C~D e* ~ c~) r~ ~2i~ r~r~ ~ r.) r~)c~) `C~) ~ - ~ g~c~ 2~i~ 0) ~ - - ~ -- ;:g~ N~) ~ C~)~ ~C~3 ~ - - ~ £%)~CA~ ~g:~ `%J(~ ~C))~ co..Jr%)wr%) ~ 0.7) Co~0.) 00)0)0.7)0.7) 07) .~0)C) UI C0)70)o~ N.) 00) COlD -.J'-J .~ .~ 0.11 ~ N) ~ 0.1fl-~0)CO ~0)Ul - - 00)0000 C0U1~-.J -~(0)o~ 0.0 - COD) ~ CD~UIC0 - 0)0.7)00) )oDr~..) ~ `C0 0~.4r..) W0)C.TIUI C)-'000...)s-' .~0.0©-..1 .~~-~N)C0)00 PAGENO="0437" 423 ATTACHMENT 2 COMPARISON OF ESTATE TAX EXEMPTION AND ESTATE TAX CREDIT IN BRINGING ABOUT RELIEF FOR FAMILY FARMS AND SMALL BUSINESS An estate tax An estate tax exemption of: credit of- $100,000 =$20, 700 $114,333 =25,000 $131,000 =30,000 $147,667 =35,000 $163,333 = 40, 000 $197,667 =50,000 COMPARISON OF REVENUE LOSSES BETWEEN EXEMPTION AND EQUIVALENT CREDIT (FISCAL YEAR 1977 BASIS) Revenue 1088 (in Exemption: billions) $100,000 $1. 1 $114,333 1.3 $131,000 1. 5 $147,667 1. 9 $163,333 2.0 $197,667 2. 3 Credit: $20,700 1 270 $25,000 1 550 $30,000 1 840 $35,000 1. 1 $40,000 1.4 $50,000 1. 7 1 In millions of dollars only. Source: U.S. Department of Treasury. 1977 projections by staffs of Senators Nelson and Packwood. SUPPLEMENTAL STATEMENT OF SENATOR GAYLORD NELSON TAX EFFICIENCY AND AN ESTATE TAX CREDIT There is little question as to the pressing need for Inheritance tax relief for those families that want to continue operating a family farm or other family business. In a growing number of cases, such relief may make the difference between their ability to "keep the business in the family" or actually being forced to sell out. But of course the great problem in providing general estate tax relief is its substantial cost in lost tax revenue. The fact that estate tax relief is ex- pensive means that any such relief the Congress does provide must be as "efficient" as possible. That is, the relief provided should go where we want it to go and not be dissipated broadly. It should accomplish what we intend it to at the lowest possible cost in lost tax revenue. This consideration, among others, has led Senator Packwood and me to introduce legislation calling for a new approach in federal estate tax relief, one that would replace the traditional $60,000 exemption with a basic tax credit. This new tax credit approach is embodied In Senate Bills S-3139 and 8-3140. The great virtue of the tax credit approach over an Increase In exemption level is that it can provide substantial tax relief to the smaller taxable estates at a much lower total revenue cost than the same amount of tax relief for these smaller estates would cost if provided through an increased exemption. The same size of tax-free estate can be achieved indirectly through a tax erdit as through any particular increase in exemption-but always at a substantially lower revenue cost. This is illustrated in Table 1 and Table 2 below. A tax credit of $25,000 for example would make all estates tax-free up to a net value of $114,333 at a 1977 revenue cost of $550 million (as estimated by the Treasury Department), while raising the exemption directly to $114,333 would cost an estimated $1.3 billion in 1977 (as projected from Treasury estimates). PAGENO="0438" 424 The reason the tax credit is so much more efficient in providing tax relief to smaller estates, as compared to an increased exemption, is that the exemp- tion is always worth more to large estates than to small ones-and any increase in exemption level gives a steadily increasing amount of dollar tax reduction the larger the size of the taxable estate. The tax credit, by contrast, is worth the same dollar amount in tax saving from the statutory rate tables whatever the size of the estate. The effect of enlarging the size of tax-free estate `indArectig through a tax credit, rather than directly through raising the exemption, is to give the greatest dollar amount of actual tax reduction to the smaller estates, while the dollar amount of tax reduction phases down for the larger estates, eventually reaching a "break-even point" as a fairly large size of estate where no further tax re- duction is provided by the credit. For example, the "break-even point" where the tax reduction resulting from a credit of $25,000 would phase down to zero is $1,303,000 in net taxable estate size. That is, a $25,00Q credit would produce some tax saving for all net estates up to $1.303 million, but a declining amount of tax reduction on all estates larger than $114,333. This is illustrated in more detail in Table 3 below. As noted, this is the reason the tax credit is such an efficient means of pro- viding tax relief to smaller and middle sized estates, without dissipating the relief provided in unwarranted tax breaks to all larger estates as well. There is a second important sense in which the legislation introduced by Senator Packwood and myself aims to be efficient in targeting some of the tax relief provided to family operated farm and small business estates as such, where the need for relief clearly is greatest. We believe that this can be ac- complished by providing an optional higher credit for those estates consisting substantially of farm or small business properties, where the enterprise has been operated by the family for a number of years, and where it continues to be actively operated by family members after the death of the decedent. Our bill suggsts a credit of $40,000 for these qualifying family-operated farm and business estates. This would make all such qualifying estates tax free up to a net value of $103,333. Given the average level of deductions of all kinds claimed against gross estates in 1973, this corresponds to a tax-free average gross estate of nearly $200,000, if the marital deduction is not used, or nearly $400,000 where the 50% marital deduction is used. Thus, our bill would provide substantial tax relief for family-operated farm and small business properties. Its revenue cost would not be excessive, how- ever, as the extra tax relief resulting from the $40,000 credit would be narrowly targeted to farm and small business estates, which are only a small part of all taxable estates. Testimony before the Ways and Means Committee in 1973 indicated that perhaps 5% of federal estate tax revenues come from closely held farm or small business properties. More recently, Richard Covey has testi- fied before the Senate Small Business Committee that he believes a more realistic estimate of farm and other closely held business estates would come to 10 or 11% of the total. Our rough cost estimates are based on the very liberal assumption that as much as 15% of estate taxes may originate with farm and other small business holdings. On this assumption, the total revenue cost of our primary proposal is an estimated $680 million in 1977. Of this amount, approximately $10 million would go to farm and small business estates under the $40,000 special credit, while $470 million would go to other taxable estates under the basic $25,000 credit. While more than 2/3 of the total tax relief under our proposal would thus still go to non-farm or business estates, nevertheless in a relative sense It would shift an adequate share of the total benefits to the farm and small business estates. For comparison, a single credit of $30,000 would cost more in overall revenue loss, estimated at $840 million in 1977, but only $180 million of this (at most) would go to farm and small business estates. while at least $710 million would go to other estates. The cost estimates and several others are compared in Table 4 and Table 5 below. Some of the detailed effects of our proposals on estates of various sizes are shown In tables 6, 7 and 8. PAGENO="0439" 425 TABLE ]. Comparison of Estate Tax Exemption and Estate Tax Credit in Bringing About Relief for Family Farms and Small Business Achieves same An Estate Tax Tax-free An Estate Tax Exegption of Net Estate as C~to~_ $100,000 $20,700 $114,333 $25,000 $131,000 $30,000 $147,667 $35,000 $163,333 $40,000 $197,667 $50,000 Comparison of Revenue Losses Between Exemption and Equivalent Credit (FY 1977 basis) Exemption Revenue Loss Credit Revenue Loss $100,000 $1.1 billion $20,700 $270 million $114,333 $l~3 billion $25,000 $550 million $131,000 $l~5 billion $30,000 $840 million $147,667 $1.9 billion $35,000 $1.1 billion $l~333 $2~0 billion $40,000 $1.4 billion $197,667 $2.3 billion $50,000 $1.7 billion Source:, U.S. Dept. of Treasury and projections by staffs of Senators Nelson and Packwood, PAGENO="0440" TABLE. 2 Federal Estate Tax Estimated Revenue Cost of Raising the Exemption Level, OR ALTERNATIVELY of Replacing the Exemption by a Tax Credit Achieving the Same Tax-free Net Estate Est. Change in Tax Revenue froigpresen Tax-free Net Estate Achieved through Direct Exemption $ 60,000 (present law) 110,000 exemption 114,333 131,000 147,667 163,333 197,667 Fl 197591 $ -0-- -1.0 billion -1.2 -1.4 -1.7 -1.8 - * -2.1 Tax Credit Required to achieve same Tax-free Net Estate Est. Change in `Tax Revenue from Present 1 Fl 19759/ - Pt i977~7 $ 9,500 +$ 740 million 20,700 25-, 000 -1- 90 " * - 400 - " (-$ 270 mi1.)~/ - -$ 550 mu 30,000 - 700 " -840 35,000 -1.1 bi]. 40,000 - 940 -1.4 50,000 -1,320 - -13 " - Source of revenue estimates: - - * - * a/, d/ Department of the Treasury * - * - - * hi Nelson/Packwood stafL * - ci Congressional Research Service The equivalent levels of Direct Exemption and Tax Credit achieving the same tax-free net estate are calculated directly ftom the statutory rate table. * - - - - PAGENO="0441" TABLE 3 Tax Effect of Alternative Levels of Estate Tax Credit (NAXIBUM TAX-FREE ESTATE) (REVENUE BREAK-EVEN POINT) ELIMINATES the Tax on Estates up to: REDUCES the Tax on Estates up to: A Average Gross Estate (Net Average Gross Estate Tax Taxable w/o with Taii~le w/o Credit Estate Ma~TEal MI~TEal Estate Maiital Marital. of of) Deduction Deduction of) - Deduct~pp Deduct~p $ 20,700 ($ 100,000) $ 122,000 $ 21114,000 (s 550,000) $ 6~o,od0 $ 1.3 mill ~25,OOO ( 1111,333) 139,000 279,000 (1,303,000) 1.6 mill. 3.2 30,000 (131,000) 160,000 320,000 ( 2,515,000) 3.0 " 6.1 ~s,ooó ( ~ 180,000 360,000 ( 3,6140,000) ~ 8.9. 110,000 ( 163,333) 199,000 398,000 ( 5,O55,OOO~ 6.2 12.3 50,000 (197,667) 2111,000 1182,000 (unlimited) unlimited unlimited PAGENO="0442" Benefit to Benefit Total Split Family Operated to All Other Revenue Credit Farm or Business Estates Cost (in millions) (in millions) (in millions) $ 20,700 general~ $ 230 30 000 farm or business ~ 130 $ 360 20 700 general 230 35 000 farm or business 170 400 20,700 general 230 40 000 farm or business 210 2440 25,000 general 470 35,000 farm or business . . 170 r2~p00 general 470 S 3t39~~~ farm or business 210 428 TABLE 24 Revenue Costs of Alternative Levels of Estate Tax Credit Estimated 1977 Levels Reduces Aggregate Taxes (in millions of dollars) For a total Revenue Cost (in millions) A Tax Credit of $ 20,700 25,000 S-3:*O ______ 35,000 40,000 for all other estates (at least 85% of total revenue cost) for farm and small business estates (at most 15% of total revenue cost) $400 80 130 170 210 $230 $270 470 550 710 1~ 840 960 1,130 1,210 1,420 640 PAGENO="0443" 429 TABLE 5 ~stitnated 1977 Revenue Cost of Proyosed Estate T~Re1tef Heres Exemption of $200,000 of taxa1~1e estate $ 2.3 billion Exemption of $150,000 of taxable estate 1.9 President's proposal (modified rate structure, tax-free net estate of $150,000) 1.1 Exemption of $131,000 1.5 Exemption of $114,333 1.3 " Nelson/Packwood Bill S-~]4Q ($30,000 general credit, tax-free net estate of $131,000) `$~~~tllion (eat. relief to farm and small bus, estates $130 mil. " " all other " 710 " Packwoo~JNe1son BLll~ S'~i~ ($25,000 general tredit, $40,000 special credit for family-held farm and small-business estates = $163,333 tax-free net estate) $ 680 mu. (est. relief to farm and small bus. estates $210 mu. " " all other " 470 " ) General Tax Credit of $25,000 (tax-free net estate of $114,333) $ 550 million (eat. relief to farm and small bus. estates $80 mil. " " all other " 470 " ) PAGENO="0444" TABLE 6 Effect of $114,333 Direct Exemption and Alternative $25,000 Tax Credit Compared With Present Law Net Present Effect of $114,333 Exemption Effect of $25,000 Credit Average Gross Estate Taxable Tax (Tax Saving Change in Tax (Tax Saving Change in Tax (in $ thousands) Estate Liability Due to Liability from Due to Liability from ___________ Exemption) Present Law Credit ) Present Law -~ $ 73 ( $ 146 with marital $ 60,000 $ -0- ( $ 9 500) $ -0- ( $ 9500) $ -0- .~ deduction ) a ~, 122 ( 244 " " " ) 100,000 4,800 ( 20,700') ~4,8O0 ( 20,700 ) -4,800 ~ 139 *i ( 270 " " " ) 114,333 8,083 ( 25,000 ) -$,083 ( 25,000 ) -8,083 -~ 244 ( 488 " " " ) 200,000 32,700 ( 34,013 ) -1.6,013 ( 25,000 ) -7,000 610 ( 1,220 " " " ) 500,000 126,500 ( 36,587 ) -17,387 ( 25,000 ) -5,800 1,220~ ( 2,440 " " " ) I million 303,500 ( 42,303 ) -20,103 ( 25,000 ) -2,800 Ia~ ~ 1,589 ( 3,178 " " " ) 1.303 VI 0 2,440 ( 4,880 " " ) 2 " 726,200 ( 51,450 ) -24,450 ( 25,000 ) + 2,500 6,100 12,200 " " " ) 5 " 2,430,400 ( 72,030 ) -34,230 ( 25,000 ) + 12,800 12,200 24,400 " " " ) 10 6,042,600 (86,893 ) -~~1,293 ( 25,000 ) + 20,600 PAGENO="0445" TABLE 7 DISTRIBUTION OF TAX BURDEN BY VALUE OF NET ESTATE $131,000 Exemption and Alternative $30,000 Tax Credit Compared with Present Law $ -0- ($ 9,500) - 4,800 C 20,700) -12,580 C 30,000) -20,680 C 38,680) -22,720 ( 41,920) -26,270 C 48,470) -31,950 (58,950) -44,730 C 82,530) -53,960 C 99,560) Inange in ~ax 1iax Saving Liability from Due to Present Law Credit) a `~ $ -0- ($ 9,500) J ~ 4,800 ( 20,700) ~ I `d+~ -12,580 ( 30~000)) -12,000 ( 30,000) -- -10,800 ( 30,000) - 7,800 ( 30,000) - 3,000 ( 30,000) -0- (break-even point) + 7,800 ( 30,000) +15,600 C 30,000) Effect of $131,000 Exemption: ~Change in Tax (Tax Saving Liability from Due to Present Law Exemption Effect of $30,000 Tax Credit: Tax (Tax Saving Liability Due to Value of * Under $60,000 Net Estate_/ Present Law Exemption) a ~ ~$ 60,000 $ -0- ($ 9,500) ~ 100,000 4,800 C 15,900) 131,000 12,580 C 17,420) 200,000 32,700 C 18,000) 500,000 126,500 C 19,200) 1 million 303,500 C 22,200) 2 " 726,200 C 27,000) 2.515 " ~ 976,150 C 30,000). 5 " 2,430,400 C 37,800) 10 " 6,042,600 ( 45,600) :~ ~iafter Marital Deduction and all other deductions, but before exemption. **/ - break-even point: no change in tax liability from present law if exemption replaced by $30,000 tax credit. PAGENO="0446" TABLE 8 Examples of Tax Savings With ~o% Marital Deduction and $30,000 Tax Credit Gross Estate, debt clear $200,000 $300,000 01400,000 $500,000 $600,000 Less 1973 average level of all non-marital deductions (18%) 36,000 511,000 j~, 000. ~ ~ Adjusted Gross Estate - 1614,0.00 2146,000 328,000 1410,000 1492,000 Less marital deduction 82,000 123,900 i614~000 205,000 ~ Net Taxable Estate 82,000 123,000 1611,000 205,000 2116,000 ~~abi1it .* Under present law . 1,880 10,3110 21,900 311,200 146,500 :~th $30,000. TaxCredit- -0- -0- 9~90~ 22,200 ~99~ *Tax Saving .:~ . . $ 1,880 $ 10,3110 $ 12,000 0 l2,OGO $ 12,000 1fft $30,000 Credit . (100%) (100%) . t511. 8%) (111.0%) (25.8%) PAGENO="0447" 433 S ~on~ffs~ionat 1R~ord United States tb of America PROCEEDINGS AND DEBATES OF THE 94 CONGRESS, SECOND SESSION Vol.122 WASHINGTON, FRIDAY, JANUARY 23, 1976 S434 ANALYSIS OF ESTATE AND GIFT TAX PROPOSALS INTROGUCED IN THE SENATE DUSJNG 1975 Mr. NELSON, Mr. President, as chair- man of the Select Committee on Small Business, I am pleased to inform the Sen- ate further as to the results of our hear- ings and investigations in the field of small business tax reform. On December 18,1 introduced a "Small Business Estate and Gift Tax Reform Act" proposal, S. 2819, based upon hear- togs In Washington, D.C., and various parts of the country during the past vesr-CnN100s500o'soL Recoas, Decem- ber 18, page 922683, The estate tax exemption has been Un- "lsanged and largely unexamined since 1)42. Inflation has increased 225 percent osce then, rendering the fixed-dollar estate and gift tax structure completely out of date. The heaviest burdens of this obsolescence have fallen upon owners of smaller businesses, family farms, and modest amounts of property. My remarks cissilenged the Congress, the executive branch, and private business to address in a systematic way the issues involving a revision of our estate and gift tax laws-and how they affect our free cute,. prise system. We are pleased that the Porsideit. Os January 5, and in his state of the Union address, endorsed tlse concept of estate tax reform for farm and business eatates tip to $300,000, though his proposal is only a modest step in the right direction. In that regard. we made the Presi- dent's proposal a part of a study whirls we had requested of the library of Con- gress that would catalog all of the estate and gift tax legisia)ion ososs' be- fore the Senate, and to compare their provisions insofar ao ho possible. This work of the Library of Congrees racial i is now complete and has been presented to and analysed by the Select Commit- tee on Small Business. So that the bene- fits of this study can be extended to the Senate, small business groups and the arneral public, I ask unanimous con- sent that the following three dceumentu embodying: first, a comparative analysis of the legislation in this field by the Small Business Committee; second, the background catalog of bills by the Congressional Research Service of the Library of Congress; and third, revenue estimates of various alternative pro- posals-be included in the record folios- lug my remarks. I would hope that this information will be iselpful to the Congress as it pro- ceeds to consideration of tax reform leg- islation in 1970. There being no objection, the material was ordered io be printed in the Hocooa, aafolisw.i: COMPARiSON 50 TAO MAIOR Fssiooes OF ESTATE OilS GIFT TOO LEGISL5T159 iru10050ces il Tile OS. 5EN5TE 500151 1'75 i,itogrstise, at Rndusii,,, i, set tas,sAs I ~ to I ,oettit tie sseuotsisdissted bstsa: tseeseeptiso syotess deiiusiien: sciuts presses Siuiiy so Re. In. Rs)leve I~'i~r~. Rsdue- , ts~~ bleed Sallied by yours tee of sie,siy ioisrsst eel, of tide soil. lets. ui oe,e- se per- h,id ret, see. 303 sees, Scysi, bill N,. $100,001 9118,000 sess,411 $100,101 $60,000 $110,018 ions raise 8100, 110+ 1240,000+ leg use see's e,,els iiebiiiiy sees rectal dsnpisr iiu,i,nuer, 4.. ~. .:.~ S.502 ~` .... Prs,idsnt's pnsseal a 4 4 SOlOS 4 4 4 0.2164 ~ S.2405 4 3.2267 4 S.2187 4 ~ 5. 2038 $4 4 S. 1803 3.5154 ` S.i113 4 4 4 S.927 4 4 x.7o2 4 3.079 4 S.678 4 4 a.sos 4 3,436 of S.2l7 of s.so of Sours,: Anaty,ie by Brat, Select Csmeittee on Seal) Business of sstsnist presided by Csn- gressisnat Re~es~sh Sereiee, Library sO C,ngress, Janus~y 1970. `toT era 55: to 140,0105 1976, $881,851 in 1978, end 8120,000 Ic 1580. $129,000. PAGENO="0448" ~Q~o u 0 ~ ~°1 ~ !! !iE!~E `~ ~ ii I ~ w w ~ HH~ :1 0 I Cl) ft PAGENO="0449" 0 M ~ ~ ~- ~, !~ ~ q ~ -~ ~ 4 ~i ~E; ~ ~d ~ *~` ~u ~ ~ ~ ~: ~ ~ *~ ~. *g~ ~! 9i~ ~ ~ ~ r~ d ~ ~ ~ ~ ~ ~ . : ~;q~ ! ~ : ~ ~ : ~ g~t ~ M ~ ~ ~ ~0 -.~ c~ ~ ~ ~ ~ ~ () 0 ~ !~~I~I ~! PAGENO="0450" o o o ~ ~ 0 ~ 0 z PAGENO="0451" PAGENO="0452" PAGENO="0453" ~g. ~- PAGENO="0454" 440 The CHAIRMAN. I am particularly pleased to welcome my col- league from Oregon, Senator Packwood, a member of the Finance Committee, who has taken an active interest in this and other tax matters. Senator Packwood, would you like to be heard? STATEMENT OF HON. BOB PACKWOOD, A U.S. SENATOR FROM THE STATE OP OREGON Senator PACKWOOD. Thank you. I, too, would like to have my statement in the record. Senator Nelson and I took two approaches on the tax credit method. One is a straight out $30,000 tax credit; the other, a dual tax credit, is a $25,000 tax credit for all estates and a $40,000 tax credit for family-run business or farms. And we defined "family- run" as brothers, sisters, children and even grandchildren and parents, if you were to pass it upwards, although that does not happen very often. If you continued to run the business for 5 years as one of the family members, then the credit would be $40,000, and we found that with that kind of a $25,000 to $40,000 credit, the revenue loss on it was,! as I recall, around $680 million, for fiscal year 1977, slightly less than if we went to the straight-across $30,000 tax credit without any differentiation between whether the business continues in the family or is sold. I understand there is a possibility of inequities in one of these dual-tier systems. It may go to somebody who is not in the definition of who is a family member and yet someone the decedent might have felt was a member of the family. I think, since we are trying to minimize revenue losses and at the same time trying to save what most of us, I think want to save small family businesses that are not liquid and would like to be passed on in most cases to descendants that the split provision is worth at least looking at. With that, I will close. Again, will you put my entire statement in the record, and Gay- lord and I will be happy to take questions. [The prepared statement follows:] STATEMENT OF HON. BOB PACKWOOD, A U.S. SENATOR FROM ~VHE STATE OF OREGON Mr. Chairman, and members of the Ways and Means Committee. As members of the Senate Finance Committee, Senator Nelson and I thank you for giving us time to testify about various proposals to help family farms and businesses survive the estate tax. Yesterday, we introduced legislation on this subject. Our goal is not unique. It's to ease the burden of the estate tax on small estates. The real value of the $60,000 estate tax exemption has shrunk drastically since 1942. This has led to the equivalent of tax increases for all estates, and to dismemberment and forced sales of family farms and businesses. VARIOUS PROPOSALS Many solutions have been offered. A. Increasing the estate tax exemption to $100-200,000 has been suggested. But, I do not expect this to happen, because-the revenue loss is enormous; It does not focus needed relief on small farms and businesses; and because an exemption is worth more to a large estate than to a small one. For example, the current $60,000 exemption saves $46,000 in tax for the $10,000,000 estate (77% bracket); but only one-third that amount for the $100,000 estate. PAGENO="0455" 441 B. Some have proposed a 100% marital deduction for the first $100-200,000. Whatever the merits of this, it doesn't solve the family business problem. That's because the marital deduction doesn't help to pass the farm or business to the next generation. C. Another proposal Is "alternate valuation" of farm or woodland for estate tax purposes. Under this, there would be two appraisals of a farm: One at its value as a farm; and one at its most valuable use, such as a subdivision. If the family operates the farm for five years after the death of the senior family member, the estate tax is figured on the "actual" (farm) use. This proposal could be very helpful, but it has weaknesss: It primarily helps farms, not other small businesses. Yet, any small business can have a liquidity problem when the estate tax comes due. "Alternate valuation" would give the most tax savings to the biggest, most valuable farms. Its benefits are not targeted to small farms. P. Other proposals have beeh made, such as: Allowing deferal of estate tax for 15 years, instead of the current 10 years permitted; reducing the interest rate on estate tax defered from 7% to 4%; and allowing deferal of estate tax if payment presents "hardship" to the estate, rather than the present requirement of "undue hardship." These have merit, but I am afraid they don't go far enough. $25,000/40,000 cREDIT: 5. 8189 Senator Nelson and I have introduced legislation, S.3139,. which repeals the $60,000 estate tax exemption, and creates a-$25,000 estate tax credit available to all estates. This means taxable estates (that is, gross estates minus all deductions) up to $114,383 would be free from tax, because that is the point at which taxes equal $25,000. And, the bill-creates a $40,000 estate tax credit for estates made up of bonafide, family-run small farms and businesses. This eliminates tax on all eligible taxable estates up to $163,333. The revenue loss is $680 million (FY 77). If the ea~emption were Increased to equivalent amounts, the revenue loss would be more than twice as much, $1,400 million (FY 77). ADEQUACY OF AMOUNTS The result is that, with a $25,000 credit, the tax on a $114,883 estate drops from $8,083 to zero. The tax on a $200,000 estate drops from $32,700 to $25,700. The $40,000 credit, for small, family-run businesses, reduces tax on a $168,333 estate from $22,000 to zero. It lowers tax on a $200,000 estate from $82,700 to $10,700. No exemption Increase proposed to date gives this much relief to small estates at such low revenue loss. EMPHASIS ON SMALL BUSINESS An Important part of our proposal Is that it recognizes where the greatest tax relief Is needed: Small family farms and business. Because of the lack of cash or liquid assets In small, famlly~run businesses, the surviving family members are often forced to dismember the farm or business, or to sell It to a large corporation, to pay the estate tax. Thus, the estate tax can in~rea8e the very concentration of wealth It was Intended to prevent. The $40,000 tax credit would be restricted to bonafide, family-run small farms and businesses It Is not available unless More than 65% of the ad)usted gross estate consists of a business Interest, which from five years before until five years after the date of death of the decedent, is. actively managed by, one or more family members. "Active management" requires that the businesss be the principal employ- ment of at least one family member~ TO limit the $40,000 credit to 8mG11 business, it Is phased out as taxable estate size Increase from $800,000 to $400,000. CONCLUSION These rules of course need strict analysis, to assure that they work as in- tended. If they are found unworkable, Senator Nelson and I have also intro- duced a bill, S.8140, that simply drops the $60,000 estate tax exemption and PAGENO="0456" 442 adds a $30,000 estate tax credit. This avoids the difficulty of shaping special rules for family-run businesses. however, it is less desirable than the split credit approach because it doesn't target needed relief specifically to small business. Also, the revenue loss would be $840 million, rather than the $680 million for the split credit. Thank you for hearing these views. I would like to continue to work with you as you review this and other tax proposals. The CHAIRMAN. We very much appreciate your testimony. We had some testimony yesterday from our panels that did not represent the preponderance of opinion, I think, but it was significant testimony which recommended a similar approach. We are going to be considering this matter as certainly one of the more important decisions that we are going to have to make, and your input has been very helpful. Mr. Schneebeli. Mr. SCUNEEBELI. Thank you, Mr. Chairman. I appreciate your testimony, very much, particularly your views regarding a dual credit approach. Would this approach create com- plications in some cases? For example, suppose a loyal employee has been working for a concern for 30 or 40 years and all along there has been an understanding that someday he would inherit the business. I think this is more likely to occur with a small business. I think this could pose a problem. I think this proposal has merit, certainly, but it may cause com- plications, as well. I think it is something that we should certainly consider. Senator PACKWOOD. It has complications. Just a top-of-the-head guess would be, in terms of small businesses, or small farms, probably 90 to 95 percent are passed to descendants rather than to someone outside the definition. Everything is a balance as to what you are trying to weigh off. Mr. SCHNEEBELI. That is particularly true of farms, but may not be as much so in the case of business. In business, sometimes the wife is not capable or doesn't want to carry on the business. So often, the loyal employee is the one who comes into the picture. But they are both very interesting aspects. Thank you very' much for coming. It was very stimulating. The CHAIRMAN. Are there further questions? If not, Senators, we very much appreciate your coming over here early and leading off today's panels. Senator PACKWOOD~ Thank you. Senator NELSON. Thank you, gentlemen. The CHAIRMAN. Our next witnesses are Senator Mathias and Senator Beall. We are very pleased to have Senator Beau here. Senator, we are glad to have you. Evidently, Senator Mathias has not arrived yet. STATEMENT OP HON. L GLENN BEALL, ER., A U.S. SENATOR ThOM THE STATE OP MARYLAND Senator BEALL. Mr. Chairman and members of the committee, Senator Mathias had a meeting earlier this morning and expects to be here. Obviously he has been detained. PAGENO="0457" 443 The CHAIRMAN. You will handle the situation well, I am sure. Senator BEALL. I would ask unanimous consent, Mr. Chairman, so as not to consume too much of your time, to put my complete state- ment in the record. The CHAIRMAN. Without objection, your whole statement will be in the record as will that of Senator Mathias. You may proceed, sir. Senator BEALL. Thank you for allowing us to be here this morning and for scheduling this series of hearings on estate tax reform because I think this is a very high priority item. Certainly there is no other portion of our tax system, in my opinion, which is in greater need of repair than the estate and gift tax sections of the law. I know that it is going to be a difficult task because there are many pressures on you as you go about the business of trying to make these changes to bring greater equity into the situation, I, of course, feel that there has to be a substantial change in the exemption level because I think we have outlived the $60,000 ex- emption. Time has overtaken this considerably and now it is working a very serious hardship, particularly on farms and small businesses. Therefore, I strongly urge the committee to increase this amount. However, Mr. Chairman, I am here principally to urge the com- mittee to carefully consider the approach embodied by Senator Mathias and me in Senate Bill 80 regarding the preservation of agri- cultural farmland and historic properties. Current tax laws are having a serious effect on our Nation's ability to preserve farmland and this is because the law is designed to force the heirs to sell the land. Because the land is valued for estate tax purposes on its market value rather than use value, the new owners, whether they wish to continue farming or not, are forced to put the fa~rm and its assets on the auction block to pay the tax. Federal estate taxes are driving people off our farms when we desperately need their skills, land and production. I think the effects of this ill-conceived tax situation is partiáularly evident in urban areas such as here in Washington. As residential housing developments creep farther and farther from the center city, more and more farmland is placed in jeopardy. Rural land values have skyrocketed, and when a farmer dies, his family is often shocked to find that, according to Uncle Sam, the value of that land, solely because of its proximity to urban growth, has multiplied to the point whereby. its value far exceeds the ability of the family to pay inheritance taxes on it. At that point, the heirs are forced to sell out to the developer, and another American. farm disappears. In my State of Maryland alone, more than a 1,000,000 acres of farmland, nearly one-fifth of the State's total land area, has been converted to other uses~ since 1949. By the year 2008, it is estimated that another 1,500,000 acres will be transferred from farming uses, unless we in the Congress take steps now to reverse this tremL Our proposal would assure the continuation of farm operations after the death of the previous owner by allowing the valuation of farmland, woodland or open space at its current use value, instead of the extremely inflated market value. PAGENO="0458" 444 In order to qualify, the property must have been devoted to one of these uses for a period of 5 years preceding the death of the owner. However, our proposal also incorporates tough recapture pro- visions should any of the land be converted to a nonqualifying use or zoning be requested by the owner to permit a nonqualifying use. Tax recapture provisions also apply if the heirs sell all or part of the land. S. 80 also allows the same treatment for historic properties. If a property is listed on the National Register of Historic Places, the owner can value the property at its value for historical, rather than market, purposes. This section will go far in protecting and preserving historic properties that might otherwise fall to the wrecker's ball. I might also point out that our approach is a far more economical method of dealing with this serious problem than other measures pending before you. Our legislation is estimated to cost the Federal Government only $20-24 million compared to other legislative pro- posals which often exceed a cost of $2 billion. Thus, the Federal Government would be moving to protect f arm- land at a fraction of the cost of other measures, certainly at a price that we can afford to pay because I think this is a goal we ought to try to achieve. I thank you for the opportunity to appear. [The prepared statement of Senator Beau follows:] STATEMENT OF HON. J. GLENN BEALL, Jn., A U.S. SENATOR FROM THE STATE OF MARYLAND Mr. Chairman, I want to thank YOU both for allowing me to be here this morning, and also for scheduling these series of hearings on estate tax reform. I know of no other portion of tax policy which is In greater need of repair than estate and gift taxation. The current estate tax laws are nearly thirty years old, and some key provisions, such as the e~temption level, have not undergone review since 1942. Clearly, estate tax revision Is desperately needed, and I congratulate you and the Committee on Ways and Means for taking this much-needed look Into this matter. However, your task Is certainly not an easy one. There are many varying proposals now before you, which suggest changes In such areas as the estate tax exemption level, marital deduction, and valuation of property for estate tax purposes, among others. I am sure, however, that you will be able to inte- grate these proposals into comprehensive estate tax reform legislation. With respect to the exemption level, there Is legislation now before the Con- gress which would raise the exemption to anywhere between $100,000 and $200,000. As you know, however, there is a substantial revenue Impact as these exemption amounts Increase, and as a member of the Senate Budget Committee, I fully realize that this factor must be carefully considered. flowevet, the fact Is that the $60,000 exemption Is far too low, especially for farms and small businesses. Therefore, I strongly urge the Committee to In- crease this amount drastically. ifowever, Mr. Chairman, my main purpose in appearing before you today is to urge the Committee to carefully consider the approach embodied by. Senator Mathias and me In S. 80, regarding the preservation of agricultural farmland and historic properties. Current estate tax laws are, without question, having a serious effect on the ability of our nation to preserve farmland. This occurs because the law Is designed so that a farmer's heirs are literally forced to sell the farm left to them in order to pay the estate taxes on that farm. Because the land is valued for estate tax purposes on its "market" value rather than Its use value, thO new owners, regardless of whether they wish to continue farming, are forced to put the farm and Its assets on the auction block to pay the tax. PAGENO="0459" 445 In short, the federal estate tax laws are driving people off our nation's farms at a time when we desperately need their skills and their land. The effect of this ill-conceived tax situation is particularly evident near urban areas, such as Washington. As residential housing developments creep farther and farther from the center city, more and more farthland is placed in jeopardy. Rural land values have skyrocketed, and when a farmer dies, his family is often shocked to find that, according to Uncle Sam, the valu~e of that land, solely because of its proximity, to urban growth, has multiplied to the point whereby its value far exceeds the ability of the family to pay inheritance taxes on It. At that point, the heirs are forced to sell out to the developer, and another American farm disappears. In my state of Maryland, alone, more than a million acres of farmland, nearly one-fifth of the state's total land area, has been converted to other uses since 1949. By the year 2003, it is estimated that another 1% million acres will be transferred from farming uses, unless we in the Congress take steps now to reverse this trend. Our proposal would assure the continuation of farm operations after the death of the previous owner by allowing the valuation of farmland, woodland or open space at its current use value, instead of the extremely inflated "mar- ket" value. In order to qualify, the property must have been devoted to one of these uses for a period of five years preceding the death of the owner. However, our proposal also incorporates tough recapture provisions should any of the land be converted to a non-qualifying use or zoning be requested by the owner to permit a non-qualifying use. Tax recapture provisions also apply if the heirs sell all or part of the land. S. 80 also allows the same treatment for historic properties. If a property is listed on the National Register of Historic Places, the owner can value the property at its value for historical, rather than market, purposes. This section will go far in protecting and preserving historic properties that might other- wise fall to the wrecker's ball. I might also point out that our approach is a far more economical method of dealing with this serious problem than other measures pending before you. Our legislation is estimated to cost the federal government only $20-24 million compared to other legi~lative proposals which often exceed a cost of $2 billion. Thus, the federal government would be moving to protect farmland at a frac- tion of the cost of other measures. Mr. Ohairman, estate tax reform is needed now. Senator Mathias and I offer today an effective approach to preserve farmland at small cost to the federal government. But, no matter what course the Committee decides upon, I strongly urge you to move as rapidly as possible in changing our out-moded and counter- productive estate tax laws. We cannot afford to wait any longer. The CHAIRMAN. Senator Mathias, would you like to come to the witness table. As usual, you are very timely. Senator Beall just con- cluded his testimony. If you would like to proceed with yours, we would be very pleased to hear you. STATE~VXENT 0F RON. CHARLES HoC. MATHIAS, 1R., A U.S. SENATOR ~`ROM THE ST4TE or MARYLAND Senator MATHIAS. My senior colleague very carefully shepherded his time to get the maximum utilization. The CHAIRMAN. You may proceed, sir. Senator MATHIA5. Thank you very much, Mr. Chairman. I am grateful to my colleague for paving the way here. The CHAIRMAN. Senator, if you had not shown up we would have been happy to recognize you on an independent basis. As it is, we will be pleased to hear you with Senator BealL Senator MATHIAS. Mr. Chairman, you are very generous on any partisan or nonpartisan basis. I might ask unanimous con~ent that I can file my statement in full to save the time of the committee. PAGENO="0460" 446 The ChAIRMAN. Without objection, your statement will appear in full. You may proceed. Senator M4TEIAS. I have been very much interested in this prob- lem for a number of years and over the past several years have had bills introduced to provide exemptions for farmland, for conserva- tion areas, and historic sites. It seems to me a great tragedy that in the State of Maryland, for example, where there has been a considerable impact of inflation on farm real estate, families who are genuinely interested in being dirt farmers cannot raise the money to pay the estate tax and hang onto the farms particularly if there is a problem within the family of several children where they have to divide up the inheritance and one or two want to continue as farmers but simply don't have an op- portunity to do it. It seems to me that we are not only losing the physical asset of the farms from a food producing point of view, from an open space point of view, but we are also losing a very important part of the social fabric of America which is associated with farming life. This is no small amount of real estate that we are talking about. The loss in farmland each year is approximately 350,000 acres of farmland, which is roughly half the size of the State of Rhode Island, Every year we swallow up half the State of Rhode Island. This, to me, is really a very shocking trend and one that has to be stopped. I believe that the tax incentives that we provide here would be a very valuable investment for America's future. I believe that we can make this program work and, of course, it has in it the safeguards which protect the taxpayers from any kind of exploitation by allow- ing the Government to recover in the event the farmland is not devoted or dedicated to the purposes that are stated in the bill. So that I urge, Mr. Chairman and members of the committee, that you give this the most careful consideration. It is one that I think is a real development in the future of America. I think we all talk about the bicentennial these days. This, I think, does more to pre- serve the basic values of America than many, many of the other things that we can do in this bicentennial year. [The prepared statement and attachment follow:] STATEMENT OF HON. CHARLES McC. MATHIAS, JR., A U.S. SENATOR FROM THE STATE OF MARYLAND SAVING OUR FARMLAND, WOODLAND, AND HISTORIC SITES Mr. Chairman, America has been more abundantly blessed with natural and human resources than any other nation at any time in history. This fortunate, unusual combination is the basis of our great wealth and prosperity, and has enabled us to build a nation which provides individual liberti and freedom unsurpassed in any other country in the world. Our resources and individual liberty have enabled us to make great contributions in every area of human endeavor, benefiting not only our citizens, but humanity as a whole. Our resources and accomplishments rightfully have been and will continue to be, a cause for great national pride and thanksgiving. But our natural re- sources are also rapidly becoming a cause for concern. The era of abundance has ended; increasing population and expectations put ever-increasing demands on the ability of man and nature to provide. Within the past decade we have been forced to recognize shortages in water, clean air and, most recently, energy. Unfortunately, in each case we failed to heed the warning signs of impounding shortage; we failed to take necessary actions, or even recognize the PAGENO="0461" 447 problems, before they became crises of major proportions. As a result, the nation suffered unnecessarily harsh disruptions and readjustments, and social costs were greatly increased. The recent energy crisis is an excellent example. We failed to heed the warning signs-declining domestic production; increasing dependence upon foreign oil sources; accelerating demand and waste of energy; and deteriora- tion in production capabilitits of energy resources other than oil and gas. We failed to heed the warning that the early 1970's would be the time when supply would peak at the rate we were, going. For 50 years plus, we were told that just fifteen more years of supply was left and new discoveries, plus new tech- niques kept pushing that ahead until It sounded like "cry wolf"-whieh so often goes unheeded. The Arab embargo, a blesing disguise, brought us over- night to reality. The initial collision date of soaring population and food supply Is fast ap- proaching; The crisis this collision will create will dwarf the energy crisis- for it will not merely cause a loss of convenience, or even jobs, but mass star- vation of millions of our fellow human beings. What has all this to do with inheritance taxes? Well, each year we hear about proper conservation and utilization of irre- placeable land: prime farmland, woodland, natural open spaces and historic sites. But `despite the rhetoric and untold number of pages of studies and documentation, hundreds of thousands of acres of these irreplaceable land resources are converted to other uses. The loss In farmland alone is shocking. Each year approximately 350,000 acres of farmland on the fringes of America's suburbs-an area roughly half the size of Rhode Island-are taken out of crops and converted to high-priced, high-density residential development. Resi- dential development greatly inflates the value of adjacent rural lands-but the swollen value pertains only if one wishes to sell his land to a developer. It means very little if one is determined-as many are of strong sentiment-to resist the temptation of riches and continue farming. State governments recog- nized the problem years ago and have responded by providing for differential assessment of farmland. I am proud to say that Maryland was the first state to provide for differential assessment and it did so almost 18 years ago. Since then the idea has spread to over thirty other states. But the effe!tiveness of state programs are severely limited and often undone by the Federal government when the farmer dies. For though state and local governments usually allow special, low assessment of farmland, the Federal estate tax Is based on the bloated valuation, derived from~ nearby subdivisions, shopping malls and the like. This means that when a farmer dies, his land- that may be assessed at $500 an acre for agricultural ~tirposes-will auto- matically be increased to a commercial market value of $,000_$3,000 or more per acre, if the land is close enough to a metropolitan area to be affected by speculative values. All too often, although a farmer's heirs may want to keep the land in agri- cultural production, they are forced to sell the land to developers or spec- ulators to pay the estate tax. Once farmland is sold for speculation or develop- ment purposes~ it can never be put back into farming. The result is Federally- compelled destruction of farmland' and open space in the critical environmental area bordering metropolitan regions, and the acceleration of suburban sprawl with no thought for land use or planning. But the greatest injustice of all is that the family is forced from their farm and compelled to pay an estate tax amounting to a confiscatory percentage of the value of what the estate is worth to them for the purpose to which they wish to put it. This problem relates to historic buildings, whether urban or rural, as well as to farmland An example is a historic house in a city whose destruction is compelled because it is appraised for Federal estate-tax purposes, on the value of the lot for high-rise apartments. Usually, the lot has to be sold `for the most intensive use to pay the tax. Thus the' Federal government, while allegedly promoting' hIstoric preservation through the National Register and other pro- grams, Is simultaneously requiring the destruction of historic buildings through its Illogical and unfair estate tax policy. The effect on woodland is equally destructive. Simply stated, the death of the land-owner, it is doesn't result In sale of the land for development, could cer- tainly mean clear-cutting. That is not attractive to an advocate of sustained yield management. PAGENO="0462" 448 The time has come for a revision of the Internal Revenue ~ervlce Code to protect American farmland from Government-encouraged speculation and de. struction. Tax laws and IRS policy must be amended or~ they will continue to compel the elimination of many thousands of acres of agricultural land an- nually, throughout the United States. Now is the time for action by the Ford Administration and Congress to correct this tax policy of destruction. On January 15, 1975 I introduced Senate Bill 80, which would amend the Internal Revenue Code In such a way as to eliminate these confiscatory tax policies, thereby preserving thousands of acres of these irreplaceable lands and the rights of thousands Of heirs to these lands. 5. 80 provides that should a farmer's family wish to continue the farming operation they woul4 have the option of having the decedent's interest in farmland, woodland, or open space determined by its fair market value, as at present, or by Its value as farmland, woodland, or open space. In order to qualify for this option, the property must have been devoted to one of these above-named uses for a period of 5 years preceding the death of the decedent. Obviously, qualifying for and electing to take the lower valu- ation will result in a significant tax saving and for so long as the land remains as qualified farmland, woodland, or open space, the tax saving will continue. But should any of the land be converted to a non-qualifying use, the tax saving will be recaptured by the Government. If all the land Is converted or requested rezoned, then the entire tax saving will be recaptured by the Government. If only a portion of the land is involved, then only a portion of the tax savings will be owing to the Government. Determinations as to the extent of recapture In Individual cases will be made in the same fashion as such determinations are made for capital gains. Historic property will be treated in a similar fashion. If the property is listed on the National Register of Historic Places, then an election can be made to value the property at its value for historical purposes and not at its market value. The tax saving will continue for so long as the property remains on the National Register. If the property is delisted, the tax will fall due. Should the heirs make a bone fide sale of the property or a portion thereof the tax savings may or may not be partially or totally recaptured depending on the sale price. If the price is below or equal to the low valuation in the original estate then there will be no recapture. If the sale price is equal to or greater than the fair market valuation, then there is total recapture of the tax savings. Sale prices falling between the high and low valuations in the original estate will result In partial recapture. In such a case, the tax due at the time of the sale shall be that part of the tax saving which is proportional to the gain realized on the sale. For this purpose, the gain realized shall be expressed as a fraction, the numerator of which Is the amount by which the actual sale price exceeded the land's original valuation as farmland and the denominator of which is the amount by which the fair market value of the land exceeded its value as farmalnd at the time of the original valuation. In no case, however, shall this fraction exceed the value 1. In all cases where recapture takes place, interest on the tax saving Is also due.. Such interest Is at 9 percent running from the filing date when the elec- tion of the lower valuation takes place for a period of 10 years or until revo- cation takes place. The tax saving and the interest thereon constitutes a lien on the property and then can be discharged at any time by payment in full. Mr. Chairman, the importance and urgency of legislation to solve the prob- lem I have been discussing is readily evident from the Interest in the 94th Congress; 179 bills dealing with the problem have been introduced thus far, 155 In. the House and 24 in the Senate. But that is not the the whole story: the number of co-sponsors is tremendous-my bill alone has 21 co-sponsors. The Senate bills vary greatly In magnitude, subject and cost. I would like to point out the three major advantages which I believe my particular bill offers. First, a comparative analysis of the Senate bills by the Congressional Research Services Indicates that costs of the various bills in revenue losses range from $20 million to $2.52 billion. My bill is the one with the $20 million price tag-an important consideration in our current efforts to bring govern- Inent spending and income into closer balance. Second, it preserves four cate- gories of Irreplaceable land: of the 24 Senate bills, only two others, S. 678 and S. 679, cover all four. Third, S. 80 stipulates that, if the land in question is converted to a non-qualifying use or even rezoned to permit a non-qualifying use for a period of 10 years after the death giving rise to the estate tax, then the excess of the tax liability based on market valuation over liability based on qualifying use must be paid, plus 9 per cent interest. No other Senate bill PAGENO="0463" 449 provides such stringent safeguards to prevent abuses or loopholes. These stiff recapture provisions necessary to prevent abuses and loopholes; it must be made impossible for the lower tax assessment to be afforded to "phony" farm- land already slated for development or which is developed after the estate tax is assessed. Windfall to speculators should be the last thing that should occur. In closing, I would like to reiterate my belief that legislative action in this area is long overdue We in the Congress have a great responsibility and oppor tunity. Our responsibility is to revise the Internal Revenue Code to provide equitable relief from confiscatory estate tax policy. Our opportunity is now. Mr. Chairman, I request that the text of my bill, S. 80, be included ìü the hearing record immediately following my remarks. [S. 80, 94th Cong., 1st Sess.] A BILL To prevent the estate tax law from operating to encourage or to require the destruction of open lands and historic places, by amending the Internal Revenue Code of 1954 to provide that real property which is farmland, woodland, or open land and forms part of an estate may be valued, for estate tax purposes, at its value as farm- land, woodland, or open land (rather than at its fair market value), and to provide that real property which is listed on the National Register of Historic Places may be valued, for estate tax purposes, at its value for its existing use, and to provide for the revocation of such lower valuation and recapture of unpaid tax with interest iii~ appropriate circumstances Be it enacted by the Senate and House of flepresa*ntatives of the United States of America in Congress assembled, That (a) section 2031 of the Internal Revenue Code of 1954 (relating to definition of gross estate) is amended by adding at the end thereof the following new subsection: "(c) ALTERNATE VALUATION OF CERTAIN REAL PROPERTY.- "(1) IN GENERAL.-If the executor of an estate so elects, the value of any qualified real property included in the estate shall be determined by its value for the use under which it qualifies, under paragraph (2), as quali- fied real property. "(2) DEFINITIoN OF QUALIFIED REAL PR0PERTY.-For purposes of this sub- section, the term `qualified real property' means real property ~ubstantially all of which is, and, for the 60 months preceding the date of death of the decedent, has been, devoted to- "(A) farming (including the production of agricultural commodities and the raising of livestock), "(B) woodland (including land used for the commercial production of trees and land used for scenic and recreational purposes), "(C) open space, or "(D) any use: Provided, That the property is listed in the National Register of Historic Places, either separately or as part of a district so listed. Such real property shall include residential buildings and related improve- ments occupied on a regular basis by the owner or lessee of such property or by persons employed by such owner or lessee for the purpose of oper- ating or maintaimng the real property and improvements described ifl this paragraph (2), and roads, buildings, and other structures and improve- ments functionally related to the uses listed in this paragraph (2). "(3) ELECTIoN REQUIREMEIrTS.-An election under this subsection shall be filed with the Secretary or his delegate at such time and in such form and manner as he may prescribe and shall contain, in addition to any other matter, the name, address, and taxpayer identification number of the per- son or persons to whom any interest in the property passes under the terms of the decedent's will Or by operation of law. "(4) DEFINITION OF' 0WNRR.-For purposes of this subsection, the term owner means those persons identified in paragraph (3). "(5) REVOCATION OF' ELECTION UPON CONVERSION, REZONINO, OR REMOVAL FROM NATIONAL REGIsTER.-Upon the occurrence of an event described In par- agraph (6), there shall be imposed on the owner a tax equal to- "(A) the excess of- "(I) the estate tax computed in accordance with section 2001 with respect to the decedent's taxable estate based on a valuatiOn the decedent's gross estate made as if the election provided in paragraph (1) had not been made~ with respect to such portion of the real property as is subject to an event described in para- graph (6), over "(ii) the estate tax computed in accordance with section 2001 with respect to the decedent's taxable estate but based on a valu- PAGENO="0464" 450 atlon of decedent's gross estate made after taking into account the election provided in paragraph (1) with respect to such real prop- erty; plus "(B) Interest on such amount at 9 percent running from the filing date prescribed In section 6075 with respect to the return from the decedent's estate (taking into account any extension of time granted pursuant to law for the filing of the return) for a period of 10 years or until a revocation of election occurs pursuant to paragraph 6 or 7. "(6) EVENTS CAUSING REVOCATION OF ELECTI0N5.-The tax described in paragraph (5) shall be Imposed upon the occurrence of any of the following events: "(A) the conversion by the owner of the real property with respect to which the election provided in paragraph (1) was made, or any portion thereof, to a use other than one or more of the qualified uses described in paragrapl~ (2) ; or "(B) the rezoning of such property to permit a use other than one or more of the qualified uses described In paragraph (2), If such re- zoning occurs at the request of the owner; or "(C) If such property qualified for the election only pursuant to paragraph (2) (d), removal of such property from the National Reg- ister of Historic Places. "(7) REVOCATION OF ELECTION UPON SALE. If the owner sells an interest in real property with respect to which the election provided in paragraph (1) was made, there shall be imposed on such owner a tax equal to- "(A) the excess of- "(I) the estate tax computed In accordance with section 2001 with respect to the decedent's taxable estate based on a valuation of the decedent's gross estate made as If (a) the election provided In paragraph (1) had not been made, or (b) such real property had been valued at an amount equal to the price for which the property Is sold, whichever valuation is lower, over "(ii) the estate tax computed In accordance with section 2001 with respect to the decedent's taxable estate but based on a valu- ation of decedent's gross estate made after taking Into account the election provided In paragraph (1) with respect to such real property; plus "(B) interest computed as provided in paragraph (5) (B). "(8) DUTY TO FILE RETURN.-Prior to or upon the occurrence of an event described In paragraph (6) or a sale described In paragraph (7), the owner subject to the tax imposed by paragraph (5) or paragraph (7) shall file a return with respect to such tax. Such return shall be made within 30 days after the end of the calendar quarter In which such event occurs. "(9) LmN TO SECURE TAx.-If the executor of an estate makes the elec- tion provided by paragraph (1), there shall be a lien on the real property with respect to which such election was made in the amount of the tax saving realized by the estate by virtue of such election. Such lien shall be extinguished upon payment of all taxes which become due pur- suant to paragraph (5) or paragraph (7) or at such time at which the possibility that any such taxes shall become due terminates, whichever time is later." (b) Section 1014(a) of such Code (relating to basis of property acquired from a decedent) is amended by inserting before the period at the end thereof a comma and the following: "or in the case of an election under section 2131 (c) (relating to alternate valuation of certain real property), the value thereof as determined under such section for the applicable valuation date, including any increased value on which a tax is paid is required by paragraph (5) or (7) of that subsection". (c) The amendments made by this Act shall apply with respect to the estates of decedents dying after the date of enactment of this Act. The CHAIRMAN. Thank you, Senator Mathias. We appreciate your bringing this matter to us. It is going to be one of the important de- cisions we will have to make. In our testimony yesterday it was suggested that there might be some possibility that wealthy, high-income people might cover some of their income by investing in this kind of property thereby shield- ing it from estate taxes. I don't know whether we can improvise a PAGENO="0465" 451 solution to keep that from happening, but you might give it some thought. If you have ideas or suggestions, we would be glad to hear them. Senator MATHIAS. Mr. Chairman, we had a judge in Maryland who used to say that the law operates for rich and poor alike. I think this might be the case here. It shouldn't discriminate against anyone because of lack of money or because of money. The CHAIRMAN. Except that I think insofar as investments are concerned it ought to be neutral. We should not have an incentive for wealthy people to invest in farmland because that might also raise the price of farmland. Senator MATHIAS. As long as there is a structure which we con- template in our bill. This would seem to me to make it unappealing because the recovery feature would mean that if they ever tried to get their capital out of the real estate in terms of something other than those provided, it would be very difficult for them to do it. I think if you wanted to you might construct some sort of a re- quirement of a history in which the lands hadn't been purchased obviously for speculative purposes within a certain period of time before the application, just as we have in inter vivos gifts, where, if the decedent had made the gift within a short period of time be- fore his death then it is brought into his estate and made taxable as part of the estate, something of that sort. The CHAIRMAN. I think there are ways that we can protect against it. I think the idea has a great deal of merit and I commend you. Mr. Schneebeli. Mr. SOHNEEBELI. Thank you, Mr. Chairman. I want to welcome my two neighbors. I think we share the same problem, the problem of urban expansion and incursion into farmland areas. I was reminded last week that Pennsylvania has more farmers than any other State in the Union, and I think relatively Maryland is in a similar position. For the size of the State, Maryland has an enormous number of farmers, and we share the same problem. I have been reminded several times of this problem by Congress- man Byron, who represents both of you. He has talked to me several times. And I realize that at least all of western Maryland is con- cerned about this problem. Thank you for coming. Senator MATHIAS. Thank you. The CHAIRMAN. Mr. Pickle. Mr. PICKLE. Senators, we welcome you again. I arrived shortly after you began your remarks. Senator Mathias, what you are recom- mending is primarily a change in the valuation of property-that is, on .death, whether it is based on current use or fair market value- and you doil't appear to go into the increase in the exemption par- ticularly. Do .you make reference to that in your testimony? Senator MATRIAS. We are dealing only with the question of the agricultural conservation and historic site evaluation so that it is not taxed for estate purposes. Mr. PICKLE. You do make reference that it is a great injustice if a person has to sell his property because he has to liquidate it or he cannot stay in business. That would necessitate a recommendation for the increase in exemption to some extent but you don't give a particular level of increase. 6~-872 0 - 76 - 30 PAGENO="0466" 452 Senator MATHIAS. What we do is simply say that for estate tax purposes you really look at what the property will produce on the use to which it is being devoted. I don't know what you can get per acre out of Texas land but I know that even the most thrifty and hard-working Maryland farmers have a tough time doing anything more than breaking even today because of the costs of the farming operation. Mr. PICKLE. That is true of Texas farmers also. Senator MATHIAS. That means that a fellow who has farmed all his life and done all he can do and just broken even and his farm has to be sold on his death because there is very little cash available in the average family farm. That is really the problem to which we are devoting ourselves. Mr. PICKLE. Thank you, Senator. The CHAIRMAN. Mr. Burke. Mr. BURKE. I just wish to welcome our two former colleagues back to this side of the Capitol. It is nice to see you over here. Senator MATHIAS. It is very good to be here. Whenever we are seeking greater light we come back. The CHAIRMAN. Thank you very much. We appreciate your testi- mony. Senator Haskell will be recognized. We are pleased to have you here, Senator. STATEMENT OP RON. PLOYD K. HASKELL, A U.S. SENATOR FROM THE STATE OP COLORADO Senator HASKELL. Thank you very much. I appreciate the courtesy very much indeed. Mr. Chairman and members of the committee, I have a few sug- gestions that I would put forward for the consideration of the com- mittee. The first one, which I am sure that my colleagues have addressed, is the increase in the $60,000 exemption but I will defer that until later. I would suggest, Mr. Chairman, that the estate tax is basically designed to tax wealth once in a generation. For that reason, I would suggest that you and your committee consider the possibility of 100-percent marital exemption and at the same time integrate the gift and estate tax so that basically you have one tax. Also, we should be sure that generation-skipping trusts, in fact, are taxed. Mr. Chairman, as you and the members of your committee know, a competent estate planner can probably have wealth escape estate taxation for as many as three generations, which I think is a mistake. At the same time, Mr. Chiarman, I would respectfully urge you to consider 100-percent marital deduction. I think most couples in this country consider that wealth is jointly obtained. I think that they do not make a distinction between his and hers and, for that reason, it would seem to me reasonable to give 100-percent marital exemption. I would also urge, Mr. Chairman, that you consider the possibility of making it easier to use the 10-year pay-out of estate taxes for a closely held business. I think the biggest obstacle to the use of that particular device now is the liability of the executor. Quite PAGENO="0467" 453 obviously the executor does not want to be liable for 10 years, and I would respectfully suggest, Mr. Chairman, that you and your committee consider removing that liability of the executor and putting a lien on the assets of the estate. I think that would facilitate the use of this 10-year payment device. I would urge, Mr. Chairman, that you and your committee consider the family farm situation. I know that Colorado land basically has two values and it is the only asset that I know of that really has two values. First, it has a productive capacity value, and second, it has a speculative value. I would urge on you to consider the use of the former value, the productive value as the valuation for estate tax purposes upon con- dition that the heir farm the property for as many as 10 years. We don't want to open up a loophole and allow somebody to say he is a bona fide farmer or rancher and have him prove otherwise. Also while we are doing something for small business, the farmers, and while we are hopefully doing something in the marital deduction, I think it is important to consider the situation that we have now of stepped-up basis for capital assets held at death. You pay an estate tax but you avoid a capital gains tax. I think probably it is too niuch to impose a capital gains tax at death although there would be a credit against the estate tax, but I would urge upon your committee consideration of a carry-over basis. This does not provide any hardship at death. It does not result in any further cash demands on the heir but nevertheless it closes a situation where capital gains is completely avoided. I think it is an equitable proposition. Lastly, I would like to pass out to you and your committee a chart of the estate tax. I had always assumed, Mr. Chairman, that the graph of taxation of the estate tax went up in a more or less straight line, but I find in plotting it out that it is a very unfortunate situ- ation. You have it almost going straight up between 0 to $100,000, and thereafter it levels out. Mr. Chairman, I don't know what the revenue impact would be but I would hope that you and your committee would give con- sideration to leveling out this situation. Our income tax structure isn't devised this way but here you have a situation with a steeply graduated tax and thereafter it levels out. I would hope, Mr. Chairman, that possibly you and your com- mittee, with the help of stall!, could consider leveling out the rates and see what the interaction is between that and the exemption. Possibly you might want to do both. Possibly you might want to leave the exemption where it is and lower the rates in the lower brackets. Mr. Chairman, I appreciate very much the courtesy which you have afforded me. If you or your committee have any questions, I would be glad to attempt to answer them. The CHAIRMAN. Senator Haskell, do you have a prepared state- ment? Senator HASKELL. No, I do not. The CHAIRMAN. The supplemental materials without objection will be placed in the record. Let me say, Senator, that you are well schooled in this field obviously and your suggestions are well PAGENO="0468" ~11 r,CD 0 CD 0 Ii CD - ~* 0 CD CD 0 CD `4 0 ~7b ~C, 30 N.B. Reqressive nature of increase: first $100,000 reaches a marqinal rate of 28%; increases only 17% to the next $1,900,000. UP `~`O: TW)USAN1)S OP flOLL7~S OP "~AXA'~LP PSTA~T~J~ 25fl 5')') 750 1000 1250 1500 2T000 2500 -~ - 3000 3500 PAGENO="0469" 455 Chapter 11. Estate tax. 12. Gift tax. Subchapter A. Estates of citizens or residents. B. Estates of nonresidents not citizens. C. Miscellaneous. Part I. Tax Imposed. IL Credits against tax. III. Gross estate. IV. Taxable estate. The tar shafl be- 3 percent of the taxable estate. $150, plus 7 percent of excess over $5,000. $500, plus 11 percent of excess over $10,000. $1,600, plus 14 percent of excess over $20,000. $3,000, plus 18 percent of excess over $30,000. $4,800, plus 22 percent of excess over $40,000. $7,000, plus 25 percent of excess over $50,000. $9,500, plus 28 percent of excess over $60,000. $20,700, plus 30 percent of excess over $100,000. $65,700, plus 82 percent of excess over $250,000. $145,700 plus 35 percent of excess over $500,000. $233,200, plus 37 percent of excess over $750,000. $325,700, plus 39 percent of excess over $1,000,000. $423,200, plus 42 percent of excess over $1,250,000. $528,200, plus 45 percent of excess over $1,500,000. $753,200, plus 40 percent of excess over $2 mfl~1on. $908,200, plus 53 percent of excess over $2,500,000. TITLE 26-INTE3NAL REVENUE CODE (As Amended) IWtERNAL REvENUE TITLE SubtItle B.-Estate and gift taxes CHAPTER 11.-ESTATE TAX Subchapter A-Estates of citizens or residehts PART 1.-TAX IMPOSED Sec. 2001. Rate of tax. 2002. Liability for payment. Sec. 2001. Rate of tax. A tax computed in accordance with the following table is hereby imposed on the transfer of the taxable estate, determined as provided in section 2051, of every decedent, citizen or resident of the United States dying after the date of enact- ment of this title: If the twaabie estate is- Not over $5,000 Over $5,000 but not over $10,000 Over $10,000 but not over $20,000 Over $20,000 but not over $30,000 Over $30,000 but not over $40,000 Over $40,000 but not over $50,000 Over $50,000 but not over $60,000 Over $60,000 but not over $100,000 Over $100,000 but not over $250,000~ Over $250,000 but not over $500,000 Over $500,000 but not over $750,000 Over $750,000 but not over $1 million Over $1 million but not over $1,250,000 Over $1,250,000 but not over $1,500,000 Over $1,500,000 but not over $2 million Over $2 million but not over $2,500,000__. Over $2,500,000 but not over $3 million___ PAGENO="0470" 456 Mr. GIBBoNs. May I make an observation? The CHAIRMAN, Yes. Mr. GIBBoNs. Senator Haskell, I know of your background as a tax lawyer and as an expert in this area. I appreciate your recom- mendations. I think they are very sound. I particularly appreciate your recommendation about the marital deduction because I know that as a lawyer I had to plow through all the problems it causes in families and all the problems it causes in trying to trace who earned what in order to figure out in whose estate the property really is. It is a needless harassment for people who have worked II the taxable estate i8- Over $3 million but not over $3,500,000____ Over $3,500,000 but not over $4 million____ Over $4 million but not over $5 million__.__ Over $5 million but not over $6 million____ Over $6 million but not over $7 million____ Over $7 million but not over $8 million____ Over $8 million but not over $10 million____ Over $10 million The tax shall be- $1,263,200, plus 56 percent of ex- cess over $3 million. $1,543,200, plus 59 percent of ex- cess over $3,500,000. $1,838,200, plus 63 percent of ex- cess over $4 million. $2,468,200, plus 67 percent of ex- cess over $5 million. $3,138,200, plus 70 percent of ex- cess over $6 million. $3,838,200, plus 73. percent of ex- cess over $7 million. $4,568,200, plus 76 percent of ex- cess over $8 million. $6,088,200, plus 77 percent of ex- cess over $10 million. Sec. 20O~. Liability for payment. The tax Imposed by this chapter shall be paid by the executor. PART 11.-CREDITS AGAINST TAX Sec. 2011. Credit for State death taxes. 2012. Credit for gift tax. 2013. Credit for tax on prior transfers. 2014. Credit for foreign death taxes. 2015. Credit for death taxes on remainders. 2016. Recovery of taxes claimed as credit. Sec. 2011. Credit for State death taxes. (a) In generaZ The tax imposed by section 2001 shall be credited with the amount of any estate, Inheritance, legacy, or succession taxes actually paid to any State or Territory or the District of Columbia, in respect of any property included in the gross estate (not including any such taxes paid with respect to the estate of a person other than the decedent). (b) Amount of cred4t The credit allowed by this section shall not exceed the appropriate amount stated in the following table: 1/ the taxable estate is- The maximum tax credit shall be- Not over $90,000 8/lOths of 1 percent of the amount by which the taxable estate ex- ceeds $40,000. Over $90;000 but not over $140,000 `_ $400 plus 1.6 percent of the excess over $90,000. Over $140,000 but not over $240,000 $1,200 plus 2.4 percent of the ex- cess over $140,000, Over $240,000 but not over $440,000 $3,600 plus 3.2 percent of the ex- cess over $240,000. PAGENO="0471" 457 together as a team all their lives to try to provide for themselves and perhaps provide some security for their family. I think you make good sense. I support it. Senator HASKELL. Thank you, Congressman, very much indeed. Mr. CONABLE. Mr. Chairman. The CHAIRMAN. Mr. Conable. Mr. CONABLE. Thank you also for your testimony, Senator. I would like to ask you this. I am a little uncertain about what you are suggesting in respect to leveling off the curve. Are you suggesting that we do away with exemptions and go to some sort of flat tax? These people who come in here want the exemption raised., which, of course, would make the divergency even sharper. Senator HASKELL. Congressman, as you can see, the rates go almost straight up and then level out. Mr. CONABLE. That is for the first $100,000? Senator HASKELL. That is right. I am just kicking this around. I am not even recommending it but it seems to me That if you made the effective tax-which, I guess, is 28 percent of $100,000-made that somewhere around the $500,000 mark, you would be leveling things out. Whether you would also want to change your exemption, I don't know. I never realized the nature of the curve of the estate tax until yesterday, but it is a very odd curve. I am merely calling it respect- fully to the committee's attention for just possible study and change. Mr. CONABLE. I must be confused about that. I would have thought the divergence of the curve resulted from the exemption, not from the tax rate. After you get above the exemption area, it is a pretty straight line. Senator HASKELL. Do you have my chart in front of you? Mr. CONABLE. Yes, I do, sir. Senator HASKELL. This, of course, is the taxable estate computed after the exemption, but you can see that when you go from zero to $100,000 the rates go just about straight up. Then the rates start leveling off on a slow incline. And I merely raise the question, Congressman, as to whether or not you shouldn't start at zero and not go up quite so fast. Mr. CONABLE. I will study it further. Thank you. Senator HASKELL. It is just a question. The CHAIRMAN. Are there further questions? Mr. Corman. Mr. CORMAN. Mr. Chairman, if I may. Senator, you indicated that the 10-year payout might be all right if the executor was relieved of personal liability. Would you give us just a little more information about tbat~ Senator HASKELL. Yes, Congressman, I would be glad to. I am told that the greatest obstacle to using the 10-.y~ear payout is the fact that the executor, as you know, is personally liable for the estate tax until paid. Therefore executors are obviously reluctant to use the device. My suggestion, sir, is ~that you remove the individual liability of the executor and make the estate tax a lien on the assets of the estate If what I am told is correct, I think this niight be a solution. Mr CORMAN It would appear from that, the ta~ collector is safe for the 10 years if it does constitute a tax lien because they are pretty high priority. PAGENO="0472" 458 Senator HASKELL~ Yes, sir. Mr. CORMAN. Thank you very much. Senator HASKELL. Thank you, sir. / The CHAIRMAN. Thank you, Senator Haskell, for the very excellent testimony. Senator HASKELL. Thank you very much Mr. Chairman. The CHAIRMAN. Our next witnesses are a panel including Mr. Johnson McRee, Jr., chairman, Task Force on Capital Gains, Estate and Gift Taxation, National Association of Manufacturers, along with Marshall L. Zissman of the task force; James J. Needham, chairman of the board of the New York Stock Exchange; Thomas J. Reese, legislative director, Taxation with Representation; Frank B. Reilly, general counsel, and John F. Grant, director, Government Affairs, Printing Industries of America; John C. Davidson, president, The Tax Council; and Gerald H. Sherman, counsel, Association for Advanced Life Underwriting. Your nameplates are in place and if you will seat yourselves appropriately we would be most pleased to recognize you. A PANEL CONSISTING OP JOHNSON MeRLE, JR., CHAIRMAN, TASK FORCE ON CAPITAL GAINS, ESTATE AND GIFT TAXATION, AND MARSHALL L. ZISSMAN, VICE CHAIRMAN, TASK FORCE, NA TIONAL ASSOCIATION OF MANUFACTURERS; JAMES J. NEEDHAM, CHAIRMAN OP THE BOARD, NEW YORK STOCK EXCHANGE, INC.; THOMAS J. REESE, LEGISLATIVE DIRECTOR, TAXATION WITH REPRESENTATION; PRANK B. REILLY, GENERAL COUNSEL, AND JOHN F. GRANT, DIRECTOR, GOVERNMENT AFFAIRS, PRINTING INDUSTRIES OP AMERICA; JOHN C. DAVIDSON, PRESIDENT, THE TAX COUNCIL; AND GERALD H. SHERMAN, COUNSEL, ASSOCIA- TION FOR ADVANCED LIFE UNDERWRITING The CHAIRMAN. I assume, Mr MeRee, that you will start with the National Association of Manufacturers' testimony and we would be very pleased to hear you, sir. STATEMENT OF JOHNSON MoREE, JR. Mr. McREE. Thank you. Mr. Chairman and distinguished members of the committee, I am Johnson McRee, Jr. I have my own accounting practice in Manassa, Virginia. I am appearing here today on behalf of the National Association of Manufacturers as chairman of its Task Force on Capital Gains, Estate and Gift Taxes. Accompanying me is Marshall L. Zissman, vice president of the First National Bank of Chicago and vice chairman of the task force. The NAM represents over 13,000 members, approximately 80 percent of whom are generally classified as small businesses employ- ing less than 500 workers. We also are concerned with the interests of the 25 to 30 million direct corporate shareholders and the many millions more indirect shareholders through pension plans, mutual funds and insurance companies. We welcome this opportunity to comment on various proposals which would affect the Federal estate and gift taxes. In particular, PAGENO="0473" 459 we are interested in the problems of estates comprised primarily of small businesses or farms and those proposals intended to affect these areas. In my own business, I have clients in both categories- farmers and small businesses-who face significant estate planning problems because of the businesses or farms which they own. So the proposals before you are of very widespread interest. ESTATE AND GIFT TAXES IN GENERAL Before commenting on specific proposals, I should restate the NAM's general views on estate and gift taxes as last presented in our 1969 general tax revision testimony before this committee. We view the estate and gift taxes as taxes on capital. We believe that the objective in this area should be the elimination of these tax structures from Federal use. A person's estate represents the accumulated savings during a lifetime-a large segment of the pool of capital which the economy utilizes for expanding employment opportunities, increasing productivity and increasing real wages. Any tax that is imposed on a person's savings is a drain on the capital formation process and will reduce the otherwise available level of capital for productive use. In fiscal year 1976 the estate and gift taxes are expected to produce some $5.1 billion in revenues, about 2.5 percent of all Federal budget receipts, excluding social security taxes on employers and employees. Although $5.1 billion is a relatively small amount of Federal revenues, it nonetheless is a significant reduction in overall private savings, certainly to persons and businesses directly affected by the tax. The elimination or substantial reduction of such taxes would have little overall effect on Federal Government programs but the impact on thousands of American families would be significant. We do not expect sudden action in this directiqn but we do urge that steps be taken now. THE PRESIDENT'S PROPOSAL The President has proposed that, where 35 percent of a gross estate or 50 percent of a taxable estate is comprised of a closely held business or a farm, the estate could elect a 5-year, interest-free moratorium on payments of taxes attributable to such assets. Then there would be annual installment payments over 20 years at a reduced interest rate of 4 percent. These provisions would lengthen the 10-year, 7-percent interest installment plan currently available under section 6166. Elections would be available only on payments attributable to the first $300,000 in such assets in an estate, with a dollar-for-dollar phaseout up to $600,000. We applaud this recognition of the estate tax problems peculiar to small businessmen and farmers because of the nature of their assets. They work long years to build a business, which they expect will provide for their survivors. In most cases all of the earnings' not needed for current consump- tion needs are retained within the business for future growth. As a result the business in the estate may be substantial but liquid assets for expenses, debts, and taxes, may be low or unavailable within the cash flow structure. PAGENO="0474" 460 To pay the estate tax liability, the business or an interest in a business may have to be sold. Unlike marketable securities, savings accounts and the like, a family business is not readily divisible or salable on short notice. To realize any cash, the whole enterprise must often be sold, and this can be a devastating blow. A person's inability to develop sufficient liquidity for his estate can undo the best of plans. Unfortunately the stretchout proposal relates only to the problem of the timing of tax payments in these situations, not to the more basic problem of the size of the tax liability. A stretchout of pay- ments, whether in the President's 5-plus-20-years proposals or in the existing section 6166 10-year option, does not necessarily meet the fundamental problem; the tax liability may still be prohibitive. While there may be instances where section 6166 has been useful, ex- perience suggests they are not frequent and are limited because of administrative difficulties. One specific part of the President's stretchout proposal which we support more enthusiastically is the 4-percent interest rate on install- ments. The existing 7-percent rate certainly does not ease the burden sought to be corrected. In the event that a further stretchout is thought desirable, the qualifying value of assets should not be fixed at a dollar level and then phased out. The liquidity problem faced by estates is not the result of the size of the business but it is due to the size of the business relative to the taxable estate. For example, a $600,000 taxable estate with a $600,000 business has a much greater liquidity problem than a $600,000 estate with a $800,000 business. Yet, under the President's proposal, the former receives no benefit while the latter does. RATE STRTJCTURE As noted previously, the major problem facing most estates is the size of the tax liability. To alleviate this central problem, we urge an across-the-board lowering of the rates. The current rate structure is steeply progressive from zero up to $100,000 of taxable estate, rising from 3 percent to 30 percent. The Senator, of course, just spoke to this problem very eloquently, I think. This is a straight-up line and is after, of course, the exemp- tion. It does put a particular burden on small estates. A reduction in the stepness of the progressivity of rates on the first $100,000 and spreading it out would ease the burdens on most estates. At the same time, an increase in the $60,000 exemption would be appropriate. There are many legislative proposals for a $200,000 exemption and the President recently announced that he favors a $150,000 exemption. We believe this would be more significant than the stretchout because it goes more directly to the size of the tax liability. While the NAM supports a higher exemption, we do not propose a number. In our view reduced rates should remain the primary goal. PAGENO="0475" 461 BASIS As long as estate taxes are to be imposed, the NAM believes it essential that a stepped-up basis provided to the beneficiaries with respect to assets transferred at death be retained in the law. By stepping up the basis, the beneficiary limits the double taxation effect of a later capital gains tax on realized income from the sale of the same appreciated assets taxable in the estate. In addition to these arguments of principle, there would be a practical question as well with a capital gains tax at death-the problem of liquidity. Such a system would reach unrealized gains, levying taxes on income which the estate has not received. If the estate can generate sufficient cash, it may be at the expense of selling such income-producing assets which were expected to provide for beneficiaries in the future. This would not be a desirable result, either economically or socially. Actually, economic equity would seem to suggest the granting of a credit against any estate tax for capital gains taxes paid during one's lifetime. Such taxes actually are taxes on capital itself and tend to reduce an individual's ultimate estate, so that a tax paid at death on such estate is, in effect, a second tax on capital. For this reason it might be desirable to consider such a credit. UNIFICATION Over the years, suggestions have been made to unify the estate and gift tax structures into a single transfer tax scheme. The idea is to treat all gifts and bequests in the same manner, using one tax rate structure instead of the existing two. In the abstract such a suggestion appears neat and seems logical. However, the current double structure has several virtues. First, it is well established and fairly well understood by practitioners. This is not to say that there are no problems or complexities in estate and gift areas. Indeed, it may well be the most intricate part of the Federal tax structure, which is another reason for its elimina- tion. But unification would not do away with complexities which ac- company powers of appointment, trusts, remainder interests and the like because these problems will always be associated with taxing transfers of property. What unification would do is to create a new structure which would have to exist alongside an old structure for decades while previous arrangements subject to the current structure hopefully fade away. The problems and uncertainties for testators and beneficiaries and the financial benefits for accountants and lawyers probably would rival those created by the 1974 pension reform law, commonly called ERISA. This would hardly seem desirable, Second, the present system does provide some incentive to make transfers during the life by ta~ting transfers at death at higher rates, PAGENO="0476" 462 and this is often cited as an intended result. If all transfers, during life and at death, were cumulative and taxable under one rate structure, there would be significantly less incentive. Incidentally, it could be desirable to provide a stepped-up basis for gifts in order to further stimulate transfers during life. Third, if a single tax on the transfer of property is felt desirable, consideration should be given to combining estate, gift and capital gains tax structures. All three are taxes on capital and they are all applicable upon the transfer of property. CONCLUSION In conclusion, our basic position is that the estate and gift tax structures are undesirable taxes on capital in the form of a person's accumulations during a lifetime. If the estate tax remains a feature of Federal tax law-and we don't think it should-then the burdens which it imposes on thousands of families annually should be lightened by legislation to reduce the size of the tax liability. While stretchout proposals for estates with business and farm assets may be helpful, the basic problem is the amount of tax which must be paid. Anything which reduces the impact of this tax on capital, such as the stepped-up basis feature, is a desirable mechanism and should remain intact. I have a slightly longer statement which, I believe, has been passed out and I would like to make it part of the record. The cHAIRMAN.. Without objection your full statement and the longer statement will be placed in the record as though read. Without objection all of your official statements will appear in the record as read. We will be happy if you will summarize them for us. [The prepared statement follows:] STATEMENT OF JoHNsoN MCREE, JR., ON BEHALF OF THE NATIONAL AssocIATION OF MANUFACTURERS SUMMARY The National Association of Manufacturers views the federal estate and gift tax structures as taxes on capital. While their impact on federal revenues Is not significant, their effects on the estates of many Americans-particularly owners of small businesses and farms-can be very significant. As an ultimate objective, the NAM urges their elimination from federal use. With respect to specific prOposals, the NAM holds the following views: Because the fundamental problem in estate taxation Is the size of the liabil- ity rather than the timing of payments, a general rate reduction is desirable, particularly in the steeply progressive brackets up to $100,000; As a recognition of the particular estate tax problems of small businessmen and farmers, the President's stretchout proposal for tax payments is welcome; As an attempt to address the liquidity problems of such estates, the stretch- out proposal (and sec. 6166 of the Code) should focus on situations where the business is a high percentage of the taxable estate, rather than on fixed dollar amounts; To reduce the impact of the estate tax as a tax on capital, the stepped-up basis a~ death feature should not be modified either by a capital gains tax at death or by a carryover basis; rather, consideration should be given to the allowance of a credit for capital gains taxes paid during a lifetime against the estate tax; While possibly desirable In theory, the complications which would accompany unification of the estate and gift tax structures suggest that such proposals should be studied with an overall view to the effect of all taxes on capital and capital formation. PAGENO="0477" 463 STATEMENT IntrodEction I am Johnson MeRee, Jr., owner and operator of Johnson MeRee, Jr., CPA, in Manassas, Virginia. I am appearing here today on behalf of the National Association of Manufacturers as Chairman of its Task Force on Capital Gains, Estate and Gift Taxes. Accompanying me is Marshall Li. Zissman, Vice Presi- dent of the First National Bank of Chicago and a member of the Task Force. The NAM represents over 13,000 members, approximately 80% of which are generally classified as small businesses employing less than 500 workers. We also are concerned with the interests of the 25 to 80 million direct corporate shareholders and the many millions more indirect shareholders through pen- sion plans mutual funds and insurance companies We welcome this opportunity to comment on various proposals which would affect the federal estate and gift taxes. In particular, we are interested in the problems of estates comprised primarily of small businesses or farms and those proposals intended to affect these areas. In my own business, I have- clients who face significant estate-planning problems because of the businesses or farms which they own. So, the proposals before you are of very widespread in- terest. Estate and Gift Tawes in Generai Before commenting- on specific proposals, I should restate the NAM's general views on estate and gift taxes as last presented in our 1969 general tax revision testimony before this Committee. We view the estate and gift taxes as taxes on capital. We believe that the objective in this area should be the elimination of these tax structures from federal use. A person's estate presents the accumulated savings during a life- time-a large segment of the pool of capital which the economy utilizes for expanding employment opportunities, increasing productivity and increasing real wages. Any tax that is imposed on a person's savings is a drain on the capital formation process and will reduce the otherwise available level of cap- ital for productive use. In fiscal 1976, the estate and gift taxes are expected to produce some $6.1 billion in revenues, about 2.5% of all federal budget receipts, excluding Social Security taxes on employers and employees. Although $5.1 billion is a rela- tively small amount of federal revenues, it nonetheless is a significant reduc- tion In overall private savings, -certainly to persons and businesses directly affected by the tax. The elimination or substantial reduction of such taies would have little overall effect on federal government programs, but the impact on thousands of American families would be significant We do not expect sud den action In this direction, but we do urge that steps be taken nOw. The President's Proposai The President has proposed that, where 35% of a gross estate or 50% of a taxable estate is comprised of a closely held business on a farm, the estate could elect a five-year, interest-free moratorium on payments of taxes attribut- able to such assets. Then, there would be annual installment payments Over 20 years at a reduced interest rate of 4%. These provisions would lengthen the 10-year, 7% interest installment plan currently available under sec. 6166. Elections would be available only on payments attributable to the first $300,000 in such assets In an estate with a dollar for dollar phaseout up to $600,000 We applaud this recognition of the estate tax problems peculiar to small businessmen and farmers because of the nature of their assets. They work long years to build a business which they expect will provide for their sur- vivors. In most cases, all of the earnings not needed for - current consumption needs are retained within the business for future growth. As a result, the busi- ness in the estate. may be substantial, but liquid - assets for expenses, debts and. taxes may be low or unavailable within the cash flow structure. To pay the estate tax liability, the business or an Interest in a business may have to be sold. Unlike marketable securities, savings accounts and the like, a family business is not readily divisible or salable on short notice To realize any cash, the whole enterprise must often be sold, and this can be a devastating blow A life s work may disappear and future income be lost all because of taxes which could not be cQvered by the estate's liquid assets. A person's in- ability to develop sufficient liquidity for his estate can undo the best of plans. Unfortunately, the stretchout proposal relates only to the problem of the timing of tax payments in these situations, not to the more basic problem of the size of the tax liability. A stretc.hout of payments, whether in the presi- dent's 5-plus-20-years proposal or in the existing sec. 6166 10-year option, does - PAGENO="0478" 464 not necessarily meet the fundamental problem-the tax liability may still be prohibitive. While there may be instances where sec. 6166 has been useful, experience suggests they are not frequent and are limited because of admin- istrative difficulties. One specific part of the President's stretchout proposal which we support more enthusiastically is the 4% interest rate on installments. The existing 7% rate certainly does not ease the burden sought to be corrected. In the event that a further stretchout is thought desirable, the qualifying value of assets should not be fixed at a dollar level and then phased out. The liquidity problem faced by estates is not the result of the size of the business, but it is due to the size of the business relative to the tacvable estate. For ex- ample, a $600,000 taxable estate with a $600,000 business has a much greater liquidity problem than a $600,000 estate with a $300,000 business. Yet, under the President's proposal, the former receives no benefit while the latter does. We would not oppose a change in sec. 6166 to raise the percentages (35% of gross estate or 50% ~ taxable) as a means of focusing only on liquidity, but we object to using dollar figures, particularly when they are phased out. Rate structure As noted previously, the major problem facing most estates is the size of the liability. To alleviate this central problem, we urge an across-the-board lower- ing of the rates. The current rate structure is steeply progressive from $0 up to $100,000 of taxable estate, rising from 3% to 30%. Thereafter, the rates rise much more slowly, reaching 39% at $1 million, 49% at $2 million, and finally 77% at $10 million. A reduction in the steepness of the progressivity of rates on the first $100,000 and spreading It out would ease the burdens on most estates. At the same time, an increase in $60,000 exemption would be appropriate. There are many legislative proposals for a $200,000 exemption and the Presi- dent recently announced that he favors a $150,000 exemption. We believe this would be more significant than the stretchout because It goes more directly to the size of the tax liability. While NAM supports a higher exemption, we do not propose a number. In our view, reduced rates should remain the pri- mary goal. Basis' As long as estate taxes are to be imposed, the NAM believes it essential that a stepped-up basis provided to the beneficiaries with respect to assets trans- ferred at death be retained in the law. The estate tax Itself imposes one levy on unrealized capital gains when its is applied to an appreciated asset's market value at the time of death. By stepping up the basis, the beneficiary limits the double taxation effect of a later capital gains tax on realized Income from the sale of the same appreciated asset. We oppose any proposals to tax capital gains at death or to provide a carry- over basis to beneficiaries. One tax on capital (the estate and gift tax) Is counterproductive enough, but double taxation of capital makes not economic sense at all. In addition to these arguments of principle, there would be a practical ques- tion as well with a capital gains tax at death-the familiar problem of 11- quidity. Such a system would reach unrealized gains, levying taxes on income which the estate has not received. Just as executors with liquidity problems on estate taxes are forced to come up with cash, estates with capital gains liabilities would be forced generally to liquidate something to provide cash for such taxes. These taxes presumably would apply to unrealized gains on ill- vestment real property, stocks, securities and other types of assets, as well as businesses and farms. If the estate can generate sufficient cash, it may be at the expense of selling such incomeproduclng assets which were expected to provide for beneficiaries in the future. This would not be a desirable result, either economically or socially. Actually, economic equity would seem to suggest the granting of a credit against any estate tax for capital gains taxes paid during one's lifetime. Such taxes actually are taxes on capital itself and tend to reduce an individual's ulti- mate estate, so that a tax paid at death on such estate Is In effect a second tax on capital. For this reason, it might be desirable to consider such a credit. TfnSflcation Over the years, suggestions have been made to unify the estate and gift tax structures Into a single transfer tax scheme. The Idea Is to treat all gifts and bequests in the same manner, using one tax rate structure lnstead~ of the exist- PAGENO="0479" 465 ing two. In the abstract, this suggestion appears to have considerable appeal. It is neat and seems logical. Ilowever, the current double structure has several virtues, First, it is well established and fairly well understood by practitioners. This is not to say that there are no problems or complexities in estate and gift areas. Indeed, it may well be the most intricate part. of the federal tax structure (which is another reason for its elimination) But unification would not do away with complexi ties which accompany powers of appointment, trusts, remainder interests and the like, because these problems will always be associated with taxing trans- fers of property. What unification would do is to create a new structure, which would have to exist alongside an old structure for decades while previous transfer arrangements, subject to the current structure hopefully fade away. The problems and uncertainties for testators and beneficiaries and. the fi- nancial benefits for accountants and lawyers probably would rival those cre- ated by the 1974 pension reform law, commonly called ERISA. This would hardly seem desirable. We suggest that unification is a concept which should be studied with a view to both its practical and economic effect over along period of time. Second, the present system does provide some incentive to make transfers during life by taxing transfers at death at higher rates, and this is ofi~en cited as an intended result. If all transfers-during life and at d'eath-we~~e cumu- lative and taxable under one rate structure there would be significantly less incentive. Incidentally, it could be desirable to provide a stepped-up basis for gifts in order to further stimulate transfers during life. Third, if a single tax on the transfer of property is felt desirable, considera- tion should be given to combining estate gift and capital gains tax structures All three are taxes on capital, and they are all applicable upon the transfer of property. Consideration could be given to placing them together, separate from the income tax structure. COflO~U8iOfl In conclusion, our basic position is that the estate and gift tax structures are undesirable taxes on capital in the form of a person's accumulations dur- ing a lifetime. If the estate tax remains a feature of federal tax law, then the burdens which it imposes on thousands of families annually should be light- ened by legislation to reduce the size of the tax liability. While stretchout pro- posals for estates with business and farm assets may- be helpful, the baisc problem is the amount of tax which must be paid. Anything which reduces the impact of this tax on, capital-such as the stepped-up basis feature-is a de- sirable mechanism and should remain intact. The CHAIRMAN. Our next witness then is Mr. James J. Needham, Chairman of the Board of the New York Stock Exchange. Mr. Needham. STATEMENT OP JAMES J. NEEDHAM Mr. NEEDHAM. Thank you. Mr. Chair~man and Members of the Committee: My name is James J. Needham. I am chairman of the board of directors and chief executive officer of the New York Stock Exchange, Inc. I appreciate this opportunity to ~appear again before this committee, this time to support the numerous bills alerady introduced in both the house and the Senate to raise the exemption under the Federal estate tax from $60,000 to $200,000. The Exchange interest in this issue focuses on our broad concern that the present $60,000 exemption which was adopted in 1942 when property values in estates were at mu~h lower levels, now results in taxation of many relatively small and medium-sized estates. The situation which has developed was described succinctly by Senator McGovern in his remarks in the `Senate on January 27, 1976, when he introduced S. 2875 to raise the estate tax exemption to $200,000 and to provide an alternative formula for land valuation, as follows: PAGENO="0480" 466 In that year (1942) Congress established that adjusted gross estates of $60,- 000 or more would be subject to this tax. The tax then became progressive as the estate became larger. In that day and in that age this exemption was sufficient to exclude estates of most average working Americans. Since 1942, however, land values have increased over 200 percent, stocks have Increased tremendously in value, many homes have doubled and tripled in value. With today's inflated prices, we can all testify that $60,000 buys much less now than once it did. In the any event, the federal estate tax, if only because of Inflation, has changed from a tax on the estates of the rich to a tax on the estates of the middle class. In the meantime, the very rich have solved, most of their estate problems through such devices as trusts, inter vivos gifts, or other sophisti- cated maneuvers devised by able lawyers to outwit able legislators. The net effect is that the average farmer, small businessman, professional, or wage earner who has worked hard all his life, made reasonably prudent Investments and educated his family, but who has not had the foresight, Incli- nation, er means to employ the nation's legal talent must now pay a dispro- portionate share of federal estate tax revenue. The federal estate tax system has led to a situation In whIch 1975 numbers are applied to 1942 dollars. I cannot believe that this Congress wishes these inequities to go on forever. I therefore rise to join other members of this body to offer legIslation to inCrease the exemption of decedent's adjusted gross estate to $200,000 and to place a floor on the marital deduction section at $100,000. Let me say, Mr. President, that this $200,000 figure, while it may appear large at first glance, is quite modest in fact In many sections of Iowa and Illinois, for example, It would equal the value of 180 acres of farm land. In Washington, D.C., it would be an upper-middle-class home and a modest sav- ings account together with a small stock portfolio. In South Dakota, it would be a small rancher with a cow-calf operation, sufficient machinery to operate the unit, and enough money In the bank to cover his cash flow needs. In any of these cases, death would leave heirs with a federal estate problem.' The basic factor here is simply that the values of all types of property have increased dramatically in the United States since the $60,000 exemption was established in the estate tax in 1942. For example, the index of residential, construction costs increased from 50.5 in 1942 to 181 in July, 1975.2 Similarly, the Consumer Price Index (for urban wage earners and clerical workers) for all items increased from 48.8 in 1942 to 166.3 in December of 1975.~ Stock prices show an even greater increase from 1942 to 1976, with the New York Stock Exchange Index rising from 5.93 to 53.35 and the Dow Jones Industrial Stock Index rising from 119 to 972: New York $ndex Dow Jones ndustrial 1942 5.93 119.40 1948 8.99 177.30 1974 36.13 616.24 1975 47.64 852.42 Feb. 27, 1976 53.35 972.61 Farmers also have been particularly penalized by the low exemp- tion because farm values have increased so that wives of farmers frequently are compelled to sell portions of a family farm to pay the Federal estate tax on a relatively small farm. It appears that the purpose of the estate tax is primarily to reduce concentration of wealth and only incidentally to raise revenues. `Congressional Record of Jan. 27, 1976, pp. S. 552-553. 2 Boeckh Index of Residential Construction Costs. 3 Economic Report of the President, transmitted to the Congress January 1976, Table B-42, page 220. PAGENO="0481" 467 Significant in this respect is the summary of * a conference discussion on the estate tax by a groi4 of experts at the Brookings Institute in 1965 where it was stai~ted : ~ ~ More general acceptance o~ the anti-conceut~t1ou aim, was evident ~f this goal is interpreted to mean hinder~z~g or even pr~vent1ug accumulation beyond some unspedfied amount b~ wealthy * 1nd!vidnai~, or in the view . o~ ~* some, wealthy families. Agaii~ emphasis was on wealth accumulated by inheritance, not by the first generation The dlsóussion seemed to Imply that the anti con centratlon principle is not a goal with respect to estates in the small and mod erate ranges say up to $500 000 or ~1,000,O0O and that even in higher ranges the aim is a fairly modest oné.~ With the general increases in value of property of all types since the $60,000 exemption was adopted in 1942, the result with today's dollar values has been to impose the estate tax on estates which aie much smaller in size than were ever intended to be subject to the progressive rates of estate tar. Most people are normally unaware of estate tax rates and are somewhat shocked to discover the high rate. applicable at relatively low dollar amount~. For example, the estate tax rates for au estate in the $100,000 to $250,000 range (after the $60,000 exemption and any marital deduction) is $~0,700 plus 30 percent of any amount in excess of $100,000. The large increase in the aggregate value of gross estates co~vered by estate tax returns filed 1958 72 is shQwn in the chart in appendix 1, also showing the three major components of those estates Thus, we believe that the primary intent of the Federal estate t'tx, to reduce concentration of wealth perhaps once a generation with respect only to relatively largq estates, would be better achieved if the $60,000 exemption were increased to $200,000 so that the tax would not apply to estates which under today's doflar values are small or medium-sized estates. Mr. Chairman, I would like to depart from my prepared testimony to comment on Senator Ilaskell's remark about. the 100 percent marital deduction. I think that is a ~rery intriguing proposal, which I hope that the committee will focus on It seems to me that it recognizes in 1976 that which was not recognized in 1942, that the uuonworking wife who stays at home and cares for the family and sees to it that the home and the husband are taken care of acleqnately really does not understand that there is A~i estate tax and there probably shouldn't be one She should enjoy the same status as the person who perhaps makes the money, since she really is the one who makes all of that possible by attending to these other chores, and they certainly are dignified chores, and perhaps we should give them some recognition in the estate tax. laws. I might also point out for the record that, if that were done, if you were to eliminate complet~iy or give a. 100 percent marital deduction~ you would cut out a lot of the Mickey Mouse that now goes on in the preparation of estate and gift tax returns It is a little difilcult for most husbands to explain to their wiv~s that just because the insurance policy is in her name and be has to give her the money to pay the insurance premium, that it is necessary to file a gift tax return There must be some corresponding savings to the Internal Revenue Service which has to examine all those returns and Gift Taxes", by Carl Shoup published by the Brookings Institu- 68-572~--76-31 PAGENO="0482" 468 PARTICULAR EFFECT ON STOCKS The estate tax particularly affects stock~ because stocks constitute a large percentage of asset~ in thost estates. For example, estates for which tax returns wore flied ~n 1973 were composed of the following assets: Stocks, 81.5 percent; real estate, 22.6 percent; cash, 15.6 percent; bonds, 7,9 percent; insurance, 5.5 percent; other assets, 16.9 percent. Since stocks constitute such a substantial portion of many estates and usually are the most liquid assets other than cash, it is frequently necessary to sell stocks to pay estate taxes. Such forced sales of stocks often cause either (1) stock to pass out of the hands of mdi- viclual investors to institutions which are purchasing large amounts of stock or (ii) small family-owned businesses to be merged or sold at sacrifice prices. LOSS OF ~EVENVE. While the estate tax was not intended primarily as a major source of Federal revenue, revenue from the esth~tc tax has: grown from $629,6 million in 1946 to $14 billion in 1960, $32 billion in 1970, and $4.3 billion in the fiscal year ended Juno 30, 1975.2 It has been estimated that increasing the specific exemption from $60,000 to $200,000 would result in revenue loss of $2.1 billion based on 1974 levels.3 We believe that as a result of the increase in property values- particularly in stocks which constitute a large percentage of estates- subsequent to the 1974 values (on which estimate of revenue loss was based), revenues from the estate tax will be larger than the revenue estimated on the base of 1974 levels. SUPPORT FOR INCREASING THE EXEMPTION TO $200~000 President Ford announced in an address on March 5 that he will recommend an increase in the estate tax exemption to $150,000 phased in over 5 years, raising the exemption $18,000 each year. There is broad support in both parties in both the House and the Senate to increase the estate tax exemption. In the House 70 bills have been introduced with over 140 sponsors to increase the Federal estate tkx exemption. (See appendix 2.) Most of these bills also in- elude a provision for valuing certain property on an alternative basis of existing use rather than market value, intended primarily to pro- vide a more realistic basis for valuing farm property for estate tax purposes. Many of these bills also would increase the marital deduc- tion. Bills to increase the Federal estate tax exemption to $200,000 have been sponsored by more than 102 Members (see appendix 3), and to $185,000 by an additional 23 Members (see appendix 4). * In the Senate 18 bills sponsored by 30 Senators have been intro- duced to increase the estate tax exemption. (See appendix 5.) As in the House, many of these bills would provide an alternative method 1 Estate Tax Returns, Statistics of Income 1972; Internal Revenue Service. Also see appendix 1 sbowiI~g major components of gross estate filings 1958-72. 2Statistical appendix to annual rey~ort of the Secretary of the Treasury for the fiscal year ended June 30, 1975, table iO, p. 48. Memorandum from the Economic Division of the Library of Congress Congressional Research Service in August 1975 (based on estimates from the Department of Treasugy) Congressional Record of Jabuary 23, 1970, p. S. 485. - PAGENO="0483" for valuing certain property and' sam~ would Increase the marital deduotion~: ` Sixteen~ Senators have sponsored bills to raise the estate tax exemp- tion to $200,000; ten additional Senators have sponsored bills to raise the exemption to $150,000; and one bill would raise the exemp- tion to $400,000. (See Appendix 5.) In accord with this strong support in both the louse and the Senate, the `New York Stock Exchange supports proposals to in- crease the estate tax exemption to $200,000. CONCLUSION The New York Stock Exchange supports~ the proposals to increase the exemption under the Federal estate tax fI'om $00,000 to $200,000 because we believe that the larger dollar exemption is necessary under present dollar values to adjust for the large inflation in estate values since the $60,000 exemption `Was ado~ted. A. larger exemption is particularly necessary to preserve family farms and family owner ship of small businesses, without compelling the sale of farms or businesses to satisfy Federal estate taxes. Thank you, Mr. Chairman. [The appendices follow :J Appendix I Chart i.. Major Components of Gross Estate 1958-1972. (Money amounts In billions of doilers) ~`rom: Estate Tax Returns, Statistics of Income 1972. PAGENO="0484" .4 ~ 00 ~jP~ ~ ~~/2&~0 ~ 0 (D `~1 H 0 0 0z ow a p 4 ! C ~ ~ `-1 0000 CO CO CO CO CO CO ~ .` ~ 00 CO ~ 000000.4 .4010 ~ .4 0 b~ ~ 0.4.4 C~ 00001 ~ C~ C).C~C~010101 ~Cj~0101 010101 * -~ ~ 0000 ~0 000000 .4.4000.400 ~-~0o b~ 0~ 0 Oi CO 00.4 CO 00 CO ~ 0Cm ~ : t~ .4000Cm ~ -` 0 ru ~ ru ~ ~ 0 ~ ~ C ~ 00000000000000.4.4000~ 1~ CO ~ 00 .4COCOW~-' - CO 0000000000Cm CO ** 0 .4000 CO 0 CO CO 010 ~ 00 W Cm 0 bO .4000' ~ ru * *~ ~ -~ -~ ** * -~ ~& -~ -~ b3 bOW bO~-~ -~ .~ ~ ~ CO CO bOW ~ 00 CO .4.40 W0.4O~001~0.4 WQCOCO00W. CO 00.40 ~ 0 ~ 00100 WOO ~-1 PAGENO="0485" 471 Appendix 3-Continued BILLS INTRODTJCEP IN TIlE I~OUSE IN THE 94TH CONGRESS To INcREASE THE EXEMPTION ruo~ FEDERAL EsTATe TAx TO $2O0,0O0~-~To 1~Lanw~ 5,1916-Continued H.R. 8801 McEwen Stuekey ILR. 10357 Burleson Banman Baldus H.E. 11905 Kazen Florlo ER. 12214 Fountain Heckler H.R, 12260 Dickinson Kasten H.R. 12277 Ashbrook McCollister ER. 12803 ]3urleson * Pike Cohen Smith (Iowa) Davis HR. 11422 Guyer Fenwick H.R. 11427 Risenhoover Ichord ER. 11590 flower Jenrette H.R. 11602 Melcher Spence H.R. 11770 Burleson Steelman O'Brien ER. 12051 Hagedorn Conte AppendIx 4 BILLS INTEODrCED IN THE Hotsm IN THE 94TH CONGREsS To INCREASE TIlE EXEMPTION FROM FEDERAL ESTATE TAX TO $185,000-To MARc~t 5, 1976 H R 2716 Ralisback ~ R 4872 Ralisback ER. 4323 Railsbaék C~rr Bevill ~.Haet~ch~i4t Brown (Ohio) H.E 5267: Railabacil Cederberg Kindness Cochran ER. 5612 Ralisback Collins (Texas) Moore Eshleman HR. 5705 Railsback Fish Johnson Guyer *. ~LR, 6885 Myers (Indiana) JohnsOn (Calikrnia) Lent Lott McDonald (Øeorgla) Michel Patt1s~n Shipley Simon Speliman Sullivan Phone Preen Walsh Wbltehurst Winn Appendix 5 BILLS INnuonuo~n IN TUE SENATE IN THE O4nn CONGRESS To INCREASE THE EXEMPTION PROM ~`EDEEAL ESTATE TAX-TO MARCH 5, 1976 S. 227 8. 927 S. 2465 436 * 11.73 * 2764 568 *, 1808 2894 678 * 2038 2819 679 . . 2187 : * 2875 702 * 2272 2885 PAGENO="0486" 472 BILLS INTRODVCRD IN ~ S~rn IN TIlE 94TH CoNGREsS To INCREASE THE EXEMPTION FROM FEDERAL ESTATE TAX To $200,000-To MARCH 5, 1976 S. 227 Bayh S. 1803 Burdlck S. 2465 McClure 436 Young (N. Dak.) 2187 Byrd (W. Va.) 2764 Brock 678 Dole Allen 2875 McGovern 679 Dole 2272 Roth Hart (Cob.) 1173 Curtis Abourezk Leahy Moss Stafford BILLS INTRODUCED IN THE SENATE IN THE 94TH CONGRESS To INCREASE THE EXEMPTION FROM FEDERAL ESTATE TAX TO $150,000-~To MARCH 5, 1976 S. 927 Belimon 5. 2394 Hartke 2394 Nelson fluddleston Humphrey Laxalt Mondale McGee Hollings Abourezk Hart (Mich.) Curtis BILL To INcREASE THE EXEMPTION FROM FEDERAL ESTATE TAX TO $400,000 S. 2885 Bartlett Mr. PIKE (presiding). Thank you very much, Mr. Needham. Your obvious qualifications certainly add to the measure with which we consider your remarks. Our next witness will be the legislative director of Taxation With Representation, Mr. Thomas J. Reese. ______Please proceed, Mr. Reese. STATEMENT OP THOMAS 1. REESE, LEGISLATIVE DIRECTOR, TAXATION WITH REPRESENTATION Mr. REESE. Thank you, Mr. Pike. In my testimony today I wish to support two reforms: taxation of unrealized capital gains at death or gift, and taxation of genera- tion skipping transfers. I also wish to oppose any increase in the estate tax exemption for taxpayers in general or for farmers and small businessmen. First of all, generation skipping transfers. Probably the most glaring loophole in the estate tax law is the failure to tax socalled "generation skipping trusts." Normally, a family's accumulated wealth is passed from parent to child and is subject to a transfer tax at each generation. However, under present law it is possible to escape paying the transfer tax for one or more generations by trans- fering property in a way so that it can be obtained by the trans- feror's grandchildren or greatgrandchildren without a transfer tax being paid by the intervening generation or generations. By use of highly complex devices generally in the form of trusts, a transfer tax can be avoiclQd even where the skipped generation has substantial enjoyment of the property and, in some cases, virtual control over it. The use of generation skipping trusts is illustrated by the financial affairs of Vice President Nelson Rockefeller. Over a 10 year period. Mr. Rockefeller received $38 million or 83 percent of his taxable in- come, from family trusts. Furthermore, 79 percent of the $218 PAGENO="0487" 473 million net worth of Mr. Rockefeller, his wife, and his children is in family trusts. Thanks to the generation skipping loophole, most of this wealth will not be subject to estate tax until well into the 21st century, if then. But you don't have to be as wealthy as Mr. Rockefeller to enjoy the generation skipping loophole. Among millionaire decedents, 25 percent of the noncharitable transfers were generation skipping. Furthermore, among husbands with estates over $2 million who established family trusts, 75 per- cent set up trusts which involved generation skipping, and 60 per- cent made their trust bequests entirely in generation skipping form. As a result of generation skipping transfers, control of great wealth caii pass from one generation to the next without payment of any estate or gift tax. Meanwhile, persons of more modest means are forced, for a variety of economic reasons, to leave their property to their immediate family. That property is taxed again, and again, as it passes from one gei~eration to another. Taxation With Representation recommends that transfers of wealth that can pass to a generation younger than the donor's chil- dren be subject to a surtax in addition to the regular estate and gift taxes. The surtax is intended to approximately equalize the tax burden on transfers that skip a generation with. the tax on transfers that are subject to estate tax in each successive generation. At the death of the donor, the surtax would be applied to trans- fers which the donor made which skipped a generation or more. The surtax would be imposed at a rate equal to 60 percent of the of the donor's marginal estate or gift tax rate. Adoption of the pro- posal would insure that extraordinarily wealthy families, which are now escaping the estate tax through use of generation skipping trusts, would begin to pay estate tax on the same basis as persons of more moderate means. CAPITAL GAINS AT DEATH OR GIFT Secondly, Taxation With Representation also supports taxation of capital gains at death or gift. Under present law, long-term capital gains benefit from three major tax advantages. First, the tax on capital gains can be delayed at the option of the taxpayer, year after year, until an asset is finally sold. In contrast, income from wages is taxed yearly or more often, through withholding. Second, gains from the sale of capital assets held more than 6 months are taxed at not more than half the rate applicable to ordi- nary income. Third, if appreciated capital assets are held until death, the capital gains tax is simply forgiven on the appreciation to~ that point. All of these benefits for capital gains are outrageous, but the complete forgiveness for assets that pass through an estate is the most outrageous of all. Failure to tax capital gains at death is grossly inequitable. It is inequitable because persons of small or moderate means who are forced by fh~ancial necessity to sell capital assets during life are required to pay a tax on any gain they may realize, but the tax is forgiven in the case of those whose wealth is so great that they can live comfortably without selling any of their assets during their PAGENO="0488" 474 lifetime. Thus, poorer persons must pay a tax that the rich escape entirely. This is certainly a gross inequity. The failure to tax capital gains at death also impedes efficient capital formation by locking individuals into low-yield investments. It does this by encouraging individuals to hold on to low-yield property-instead of selling it and reinvesting where yields are higher-because they know that their heirs will not have to pay capital gains tax on unrealized appreciation with respect to those assets. Finally, failure to tax capital gains at death is one of the key elements perpetuating the aristocracy of wealth that arose in this country after the Civil War. Since persons of great wealth can pass assets from generation to generation tax free, there is no prospect that the enormous disparities of wealth that now characterize our nation will gradually be reduced, unless and until unrealized capital appreciation is taxed at death or gift. A $2OO~OOO EXEMPTION Taxation With Representation also opposes increasing the estate ta~ exemptiofi. Some people have recommended raising the estate tax exemption to $200,000. This would cost the Treasury $3.4 billion annually when fully effective. A few statistics ~cvill show who would benefit from such a tax reduction. In 1~72 there were roughly 20 million adult deaths. About 175,000, or ~ percent, filed estate tax returns, and only 121,000 or 6 percent flied taxable returns. The 6 percent of decedents who would benefit are those with the largest net wealth, since they are the only decedents who are taxable. In addition, since the estate tax is progressive, an exemption will give the greatest amount of aid to the most wealthy. PORD ESTATE TAX PROPOSALS Finally, we strongly oppose the President's proposals to postpone for five years all estate taxes for farms and small businesses worth $300,000 or less. We also oppose granting to these estates 20 years to pay the tax at an interest rate of 4 percent a year. While the Ad- ministration calls this a "postponement" of taxes and not a reduc- tion, the net effect has been calculated as a 45 percent reduction in estate taxes. Someone with a $300,000 estate is not a poor person and does not need Federal assistance, A $300,000 farm i~ not a small farm. The average farm as of January 1, 1974;. had a net equity of $142,000. Only class 1A farms, with annual sales (not assets) over $100,000, had an average net equity in exCess : of $300,000. These farms constitute only 4 percent of the total number of farms. Sixty- three percent of U.~. farms fit into a class where average equity is below $120,000. It thus appears that any estate tax savings would go mainly to farmers that are already well off. Finally, increasing the exemption for farms would create a tax shelter within the estate tax. In order to avoid estate taxes wealthy people would buy up farm land sand further push the legitimate small farmer out of business. PAGENO="0489" 475 Comparable figures on the average eqnit~ o~ nonfarm businesses don't seem to be available. But we do know that 73 percent oi all poses since the estate tax is paid on net assets, which is gross assets partnerships in 1971 had gross assets under $100,000. These figures actually overstate the value of such businesses for estate tax pur- minus liabilities. Moreover, since these figures are for partnerships, any one partner would own less than the entire business. The White House proposal, with maximum benefits for estates of $300,000, would aid most partnerships, not just the smallest. Mr. Chairman, that concludes my statement. I will be happy to answer any questions. [The prepared statement follows:] STATEMENT 01' THOMAS 3. REESE, LEGISLATIVE Dxazcron, TAXATION WITH REPRESENTATION Mr. Chairman and members ~of the committee, my name is Thomas 3. Reese. I am the legislative director of Taxation with Representation, a 17,000 member public interest taxpayers' lobby founded in 1970. Taxation with Representation has a six point tax reform program which Is a product of months of discussions within our National Committee. Many of the Nation's outstanding tax attorneys and public finance economists are mem- bers of that Committee, and their overwhelming approval of our program is a clear Indication of broad professional support for these six reforms. It is de- signed to place before Congress those proposals that we believe should be given the highest priority In any legislative consideration of tax reform. Its e~ements are: ~raxation of unrealized capital gains at death or gift. Estate taxation of generation skipping transfers, Repeal of percentage depletion for all minerals. Provision of a federal interest supplement large enough to Insure that states and localities will yoluntarily issue taxable rather than tax exempt bonds. 1~epeal of the Domestic International Sales Corporation (DISC) provisions of the Internal Revenue C~cle.. .. Allocation of deductions between taxable and tax exempt inëome. I will concentratç~ my testimony today OR two aspects of this reform pro~ gram that we believe will be of special interest to the Committee during its hearings on estate and gift taxes. The first of these is the taxation of genera~ tioxi skipping transfers, th~ seáOnd äoncerns taxation of capital gains at death or gift. TAXATION 01' GENERATION SXIPPING TEANSTEItS Taxing the transfer of wealth from one generation to anojber has lông been recognized as Sound. procedure. Death aiid gift taxes are levied on taxp~re~s who, almost by defInl~ion; no longer need the money; consequently, the tax Is about as ~p~jnless as any tax can be. Death aild gift taxes can, be an important Source of government revenue, and they have minimal impact on incentives and ~lsk taking. Estate and ~g1ft taxes serve an extremely useful social purpose in breaking uØ large concentrations of wçalth, thns helping to cnrb the emergence of a self- perpetuating aristocracy of wealth whose goals and outlook~ are incompatible with democratic Ideals. ~state taxes are paid, by only 7 percent of deceçlents which me the most we~1thy people In America Finally, these taxes help to make up for the deficiencies of our loophole-rid- den Income tax, by insuring that wealth-including that accumulated through manipulation of income tax lOopholes-nevertheless bears some federal tax at least once a generation. tinfortunately, our existing system of estate and gift tazes largely falls to achieve these objectives. The present tax systerti goes too far ~n protecting the interes1~s of the immensely wealthy, while failing tt deal fairly with persons of modest means who wish to provide for their lmmedIat~ family and dependents. There are many causes of this situation, but probably the most glaring loop- hole is the failure to tax so-called "generation skipping trusts". PAGENO="0490" 476 How 4e4~e-ation ~k1ppin~i Trusts Work flnder the laws of most states, an individual can establish a trust which benefits not only his immediate family but also his more remote descendents. Typically, these trusts last about a century, and span two or three generations. That is why they are called "generation skipping trusts". Children, grand- children, and even great grandchildren can receive all of the income from the trust prOperty, and a healthy portion of the principal. They can borrow against the property, decide how It will be invested determine who will receive it upon their deaths, and in general behave during life as the true owners of the prop- erty. But, at death, the tax collector disregards these facts, and permits the property in generation skipping trusts to escape estate taxation, not just once, but in two or even three successive generations. As a result, control of great wealth can pass from one generation to the next without payment of any estate or gift tax. Meanwhile persons of more modest means are forced, for a variety of economic reasons, to leave their property to their immediate family.1 That property is taxed again, and again, as it passes from one generation to another. An example will make clear how generation skipping trusts work. Suppose that two individuals each have a taxable estate of $10 million, after all exemp- tions and deductions have been claimed. The first, Mr. Roe, leaves his entire estate to his children. The Roe Estate will owe a death tax of approximately $6 million. Assume that the Roe children invest the remaining $4 million, and that they, in turn, leave the inherited principal to their children, and so on. Thus, the Roe family estate bears a tax once a generation, and it is gradually reduced In amount, unless replenished by the work of the succeeding genera- tions. The second individual, Mr. Doe, places his taxable estate in a generation skipping trust. Like Roe, he pays an estate tax, but succeeding generation~ pay nothing, even though they receive all of the income from the testamentary trust and enjoy substantial control over the principal. This is shown in Table 1, below: TABLE 1.-EXAMPLE OF OPERATION OF GENERATION SKIPPING TRUST WITH $10 MILLION TAXABLE ESTATE Generation Roe family tax Doe family tax Donor's 2dgeneration 3d generation 4th generation $6, and, 000 $6, OdO, 00 1,800,000 - 850, 000 500,000 The use of generation skipping trusts is further illustrated by the financial data that was made part of the public record during the recent hearings on the nomination of Nelson Rockefeller to be Vice President. Over a ten year period, Mr. Rockefeller received $38 million, or 83 percent of his taxable in- come, from family trusts. Furthermore, 79 percent of the $218 million net worth of Mr. Rockefeller, his wife, and his children is in the form of interests in trusts. Thanks to the generation skipping ta~ loophole, most of this wealth will not be subject to estate tax well into the 21st Century, If then.2 The Proposal: A rgurtao, on Generation E~k4~pplng Transfers Taxation with Representation recommends that transfers of wealth (whether directly or in trust) that can pass to a generation younger than the donor's children-and hence skip a generation-be subject to a surtax in addition to the regular estate and gift taxes. The surtax is intended to approximately equalize the tax paid by the donor with respect to transfers which skip gener- 1 Estates of small and moderate size are typically left to one's wife and children, since decedens of moderate means cannot be sure whether circumstances will require their wife or children to make use of the entire estate to pay medical bills or deal with other family emergencies. Decedents do not begin to make liberal use of generation skipping trusts until family wealth becomes so enormous that no conceivable emergency could seriously deplete it. At that point, a decedent can establish long-lived trusts, secure In the knowledge that the trust inc~ome alone will adequately provide for any emergency. 2 For data on the Rockefeller hearings, ~ee Taco Notes, September 30, 1974, p. 7ff; also, House Judiciary Hearings on the Nomination of Nelson A. IIockefeller, 93rd Congress, 2nd Session, p. 25ff (~974) ; Sen. Rules and Adm. Committee, Report on the Nomination of Nelson A. Rockefeller of New York to be Vice President, Sen. Ri. Rep. No. 93-94, 93rd Congress, 2d Session, p. 24 (1974). PAGENO="0491" 477 ~tiôns with the tax his children would hate paid if the trausfer had been made to them. The tax would be levied a~ follows: At the death of the donor, the surtax would be. applied to transfers which the donor had made during a life or at death and which skipped (or which yet cOuld skip) a generation or more. rJ~he surtax woudl be ~lmposed at a rate equal t~ 60 perce~nt of the donor's mar- ginal estate or gift tax rate. $ince the highest marginal rate for the estate tax Is 77 percent, the highest generation skipping surtax would be about 46 percent of the amount passed on to remote generations, Since amounts paid in regular estate tax to the goverflment cannot be passed on to reznote generations, the Surtax would be imposed on the net estate, after subtraction of the estate tax. Thus, in our earlier example, if Mr. Doe bequeaths his entire $10 million taxable estate to a remote generation, he would pay $6 million In reguar estate taxes and a generation skipping surtax of about $1.8 million, Even under the Taxation' with Representation proposal, there will remain some tax advantage in transfers in trust which' benefit not just children, but grandchildren and `perhaps great grandchildren as welL l3ut the administrative simplicity of the generation skipping surtax proposal would be lost If an attempt were made to relate the surtax to tb~e potential tax liabilities of these remote generations. Moreover, most avoidance of estate and gift tax occurs through use of trusts that skip only a single generation. For both these reasons, the riaxation with Representation proposal does not seek to establish absolute equality between the tax situations of, the Th~e and Roe families, as set forth in Table L Instead, It pre~erves administrative simplicity, while at the same time eliminating the most outrageous aspects of the existing generation skip- ping loophole. The refOrm will raise approximately $800 million from the very wealthy. BiblograØi~y.-Tacc Reform Studies and Proposals U.S. Treasury Department, ~oiut Publièatio~ of House Ways and Means Committee and Senate Finance Committee, February 5, 1969, Part I, pp. 43-44~ 116117, 120, Part III, pp. 388- 401. Panel Discussions on General Taco Ref ormy House Ways and Means Commit- tee, February 27, 1973, Part 10. TAXATION Or CAPIPAL GAINS A~ DrAm OR On, Under present law, long term capital gains benefit from three major tax ad- vantages. First, the tax on capital gains can' be delayed at the Option of the taxpayer, year after ~veai', until an asset is finally sold. In èontrast, income ftom wages is taxed yearly or more often, through withholding. Second, gains from the sale of capital assets held more than six months are taxed at not more than half the rate applicable to ordinary income. Third, if appreciated capital assets are held until death, t1i~e capital yams taco Is simply forgiven on the appreciation to that point. All of these benefits for capital gains are out- rageous, but the complete forgiveness for assets that pass through an estate is the most outrageous 0± all. Failure to tax capital gains at death Is grossly inequithble, deters capital formation and Is therefore bad for the U.S. economy, and is a threat to our democratic social structure: It is inequitable because persons of small or moderate means who are forced by financial necessity to sell capital assets during life are required to pay a tax on any gain they may realize, bnt the `tax Is forgiven In any case of those whose wealth is so great that they can live comfortably without selling any of their assets duriug their lifetime. Thus, poorer persons must pay a tax that the rich escape entirely. This is certainly a gross inequity. The failure to tax capital gains at death also Impedes efficient capital for- mation by locking individuals into low yield investments. It does this by encouraging individuals to hold on to low yield property-~-lnstead of selling it and reinvesting where yields are higher-because they know that their heirs will not have to pay capital gains tax qn unrealized appreciation with respect to those assets. Finally, failure to tax capital gains at death is one of the key elements perpetuating the aristocracy of wealth that' arose in this country after the Civil War. Since persons of great wealth can pass assets from generation to generation tax free, there is no prospect that the enormous disparities of wealth that now characterize our nation will gradually be reduced, unless at~d until unrealized capital appreciation is taxed at death or gift. PAGENO="0492" 478 1. Ta~i, Inequities Resulting from Failure to Tacv Capital Gains at1le~it1~ or Gift The estate of a prominent member of the DuPont famii~, whO died a few years ago, furnished a graphic example of the inequities produced by present law. The individual In question owned a substantial portion Of Cecil County, Maryland, which he began to purchase in the 19g0's at depressed prices. Those who~ sold their farms to him were required to pay capital gains taxes on the proceeds of sale, to the extent that the sales price for their land exceeded the original cOst or other basis. Subsequently, the land Increased greatly in value. Yet the federal government forgave the capital gains tax on this large appreci- ation, because the individual in question was wealthy enough to hold his land until the time of his death. Thus the farmers who sold out during life were forced to pay capital gains tax, but the multi~rnlllionaire who purcha~ed their farms totally escaped tax on the subsequent appreciation in the value of the acquired land. Similarly, the federal government also forgave the capital gains tax on the banking and chemical company stock that formed part of the same lhdlvidual's estate. This example Illustrates the typical pattern under existing law those whO are forced by financial necessity to sell capital assets during life are required to pay a tax on ~any gain they may realize, but those whose wealth is so great that they can live comfortably without selling their assets know that no capital gains tax will ever fall due on any appreciation in the value of assets that they pass along to their heirs. This differential tax treatment of poorer individuals, as contrasted with wealthier persons, is illustrated in Table 1. This table compares the situation of two widows, one of moderate means, the other wealthy, both of whom are faced with the necessity of paying substantial medical bills during their last illness. The first, the Widow Jones, is forced to sell appreciated assets to cover those medjcal expenses. She is therefore required to pay a capital gains tax of up to ~5 perceht on the appreciation in the value of her stock. The second, the Widow Smith, owns a much larger amount of the same Stock, and she i~ able to pay doctor bills out of her dividend income, without selling any of her shares. She rays no capital gains tax at all, nor do her heirs, since they get the advantage of the hypothetical "stepped up basis" at the time of death. The result is that those of moderate means, like the Widow Jones, must pay capital gains tax, but those who are wealthier, like the Widow Smith and her heirs, escape tax entirely. ABLE 1.-INEQUALITY IN TAX TREATMENT OF CAPITAL ASSET HOLDERS WHO MUST SELL BEFORE DEATH, AS CONTRASTED WITh THOSE WHO CAN AFFORD TO HOLD ASSETS~FORTRAN~MlTTAL TO HEIRS Widow Jones (moderate means) Widow Smith (affluent) Personal situation. Must sell stock which has appreciated Dividends on larger amount of similar $10,000 to pay medical bills during ~tock are adequate to pay medical last illness. bills during last illness. Capital gains tax paytble Mutt pay up to $3,500 In capital gains tax. Capital gains tax payable by heirs The proposal to tax capital gains at death or gift corrects this inequity by im- posing a tax on the amount by which the Widow Smith's stock has appreciated, as of the time of her death. Consequently, like the Widow Jones, she will owe up to $3,500 in capital gains tax for each $10,000 by which her stock has appre- ciated in value. A second inequity that is corrected by imposing a capital gains tax at death relates to the unequal treatment under present law of taxpayers who seek to provide an estate for their heirs. In general, existing law discriminates against those who must provide an estate out of earned income, such as wages and sam- ries, and in favor of those who are already wealthy, especially those who have inherited their wealth. Contrast, for example, the situation of Mr. White, who is a salaried corporate executive, and Mr. Black, who inherited substantial wealth in the form of land and corporate securities. Suppose that each wishes to provide an additional estate amounting to $100,000 for a child. White decides to take a second job to earn this amount; Black decides to earmark the appreciation in the value of his land and stock. Under present law, the government will take up to half of White's PAGENO="0493" 479 earnings In incon~e tax, thus rnaklzjg~t twjee as dilflcult for him tø provide an estate for his belts, but it will nOt Impose' any similar tax on the ~pprecia~ion in th~ value of Blaek'iland and stOck. Thus, the income tax law puts a Substan- tial barrier in White's way, If he' seeks to create ~n estate for laja `heirs, but no similar barrier iscreated in the `case of Black. This is illustrated In Table 2: TABLE 2.-INEQUALITY IN INCOME TAX TREATMENT OF TAXPAYERS SEEKING TO PROVIDE FOR THEIR HEIRS Mr. White (salaried executive) Mr. Black (Inherited wealth) p~ersonal situation Has 1 Job and takes a second to provide Owns land and corporate stock. Lives for child's bequest. ` on'rents and dividends. Earnings situation Earns $100,000 in a~lditional wages Land and stock increase $100,000 in from second job for child, value; Increase is earmarked for child. Additional income tax payable Up to $50,000 Remainder for transmission to heIrs_~. $50,000 $100,000. Taxation of cai~ita1 gains at death or gift will help to correct this Inequity by imposing a tax on the appreciation of Mr. Black's stock when he dies or makes a gift of `the stock to his child. The tax imposed would be levied at capital gains rates, thus resulting In a tax of up to $g5,000. Black would there- fore still be somewhat better off than White, because we tax capital gains at lower rates thau ordinary wages, but the shocking inequality produced by existing law would be sharply reduced. 2. The "Lock In Effect" resulting from Failure to Ta~v Capitol Gains at Death or Gift One of the basic advantages Of the free market economy is that capital tends to flow into those uses where the rate of return is the highest. This helps to expand production in those areas where expansion is most needed, and insures that we are m~~lng best use of scar~e capital resources. But this basic economic mechanitim cfannot operate if there~ are barriers to the free flow of capital, Among the most s~ipu~ of~ theae barriers in the `~lock in effect" resulting from failure to tai capital gains at death or gift. In substance, present law presents an individual with the following chok~e: lie can sell ,a relatively unproductive capital asset and reinvest Where `tb~ rate of rettfrn is' higher, but" in tha~ ease he will have to pay an immediate capital g~Jxis tax of up to 8~%. Or lip" can hold on to his relatively low yield asset until death, in which ease i~o `capital gainS tax will ever, be due, from anyone. tYnder these ctrcumstances, it is not surprising that many individuals, particularly in the upper age and we~it1th bracket~, hold on to capita~ assets for tax reasonS, even thought the, yieI~ on those asseth is. relatively, low. In `effect, they are "lock `in" to their present investments by the tax law. This freezing of economic assetS obviously `bátt~s indWicluals by forcing them to accept lower yields than they could otherwise enjoy., It also harms the econOmy `by impeding, the iThw of capital intO those ar~s whOre the need "Is greatest and. where,' as a consequence, the rate of returt~ on investment Is generally highest. The taxation of ,capital gains at death or gift would sharply decrease the lock in effect. There would be no,ipcentlve to hold onto as~ete in the `hope of escaping. capital gains ta~ eoui~1~ete1y. Instead, a tax would be due whether an individual sold assets now or held them until the' time of his death. The decision frbéther to sell or to, hold' would be based to a much greater degree on economic rather than tax factors, with consequent benefits for the American economy. 3. The' Revenue Loss Aitrlbutcsble to Failure to Two qapital Gains at Death or Gift During l975, the federal government lost apprpximately $2.4 billion in rev- enue as a result of failure to impose a capital gaIns tax on assets passing at death. or by gift, This 1s `a revenue loss large enough to have linanced the combined outlays of the Departments of Commerce and State during 1975, with somethIng left over. Obv1~usly a re~e1ine~ hss thls:large must be ended, espe- cially when there are no oftsetting gains. d~rtved from continuation of this loss. PAGENO="0494" 480 4. The Proposed TreGtment of Capital Gains at Death or Gift `To remedy the problems just tiescribed, persons holding appreciated capital assets a.t the time of their death would be treated as if they had sold those assets just prior.to death. The resulting gain would be taxed In the final income tax return of the decedent. The tax rate would be the san~e as that now appli- cable to assets sold during life. Similar rules would apply in the case of trans- fers by gift. A deduction for the income tax paid would be allowed in determin- ing the amount of property subject to the estate or gift tax. Thus, the taxable estate or gift would be "net of income tax paid," as is now the case for those who accumulate their estates out of ordinary wages or other income, or out of capital assets that are sold prior to death. Capital assets that are taxed at death under the proposal would continue to acquire a stepped up basis at death, as under present law. In the case of gifts, a sfepped up basis wOuld be sub- stituted for the existing carryover basis provision, To facilitate adoption of the new system, various transitional rules can be devised, but care should be taken to insure that these rules *do not result in loss of all or most of the immediate revenue gain that will result from adop- tion of the proposal to tax capital gains at death or gift. To assist In payment of the capital gains tax in cases in which estates lack liquid funds the stock redemption and installment payment provisions of Sec tions 303, 6161, and 6166 of the Internal Revenue Code will be available. Bibiiopraphy.-Taa~ Reform Studies ~nd Proposals U.S. Treasury Depart- ment. Joint Publication of Rouse Wafu and Means Committee and the Senate Finance Committee, February 5, 1969, `Part I, pp. 28-29, 42-re, 104-107, 118- 119; Part 3, pp. 831-~351. Panel Discnssions on General Taco Reform, House Ways and Means Commit- tee, 83rd Congress, 1st Session, February 27, 1973~ Part 10. Basic Fiscal Principles Underlying these two tax reform proposals are basic fi~cal principles that we believe should have wide application as you consi4er tax reform legislation These same principles are the foundation stones ~for the w~rk of Taxation with Representation. Briefly summarized, they are The tax system should be used primarily to raiSe revenue. The use of tax subsidies to Influence business and pe~sonal decisions should be a last resort, ~iot the first solution proposed for social problems. Direct government expenditures, which are subject to periodic accounting and review, are almost always a less expensive way of attaining public goals than are tax subsidies. Tax deductions, credits, and exclusions usually confer their greatest benefits on those individuals and firms that are in the best financial condition, and glve little or no help to those really In need. Most deductions, credits, and exclusions erode the tax base and increase the tax burden that must be borne by others. This shifting of tax burdens is an important source of unfairness In the federal tax system. Fairness requires that persons with similar 1n~omes and assets should be taxed alike. Fairness also. requires that those who have more should pay more than those who have less. A tax system is Unsuitable for a democracy if It cannot be understood by the taxpayers themselves. And a tax system whose needless complexities waste the tIme and energy of thousands of accountants, lawyers, economists, and ordinary citizens demands simplification. BAD "REFORM" A $200,000 EXEMPTION There are a number of changes in the Estate and Gift tax laws which have been masquerading as "reform" which Taxation with Representation strongly opposes. Specifically we oppose increasing the estate tax' exemption for either all taxpayers or for farmers and small businessmen. A number of people have recommended Increasing the estate tax exemption to $200,000. The principal argument in favor of Increasing the exemption is that Inflation has eroded the value of the exemption so that $200,000 today is worth about what $60,000 was when that figure was eStablished a generation ago. Treasury estimates the revenue loss from increasing the exemption to $200,000 at about $2 billion annually, nearly half the total of estate tax col- lections of $4.2 billion in 1972. PAGENO="0495" ~t8i . ~ . Deaiing~w~t1& In~ion : ; ~ ~ ~ ~ ~ ~ ~ ~ It is true that Inflation causes capricious changes in the intent o~ * COngresa. Regular inflation adjustments could be made b~ tying e~einptions and tax brackets to a price index. However, the proposed ciLai~ge to an exemption of $200,000 assun~es that we want to restore the conditions of a generation ago, an assumption that is hasty at best The proposed change is best evaluated In terms of its effects on the existing world of 1970 We must ask what the distribution of the b~neftts of the proposal will be under today's conditions, what the best level for the estate law exemption is and what ç~banges we want in the estate tax law as It now exists. There are several major deductions from the gross estate to get the `tax- able estate Besides the existing $60 000 exemption, one ~ubtraOts admuiistra tion and funeral expenses, indebtedness, taxes dne charifable bequests, and the marital deduction (which usually amounts to half the gross estate) For this reason, estate are not normally taxable until they are well in excess of $100 000 and rates increase from 3% for the first $5000 in the taxable estate to 77% for over $10 mjiflon. Thus, a $200,000 gross estate will frequently pay an estate tax of only 3% on a taxable estate of $5 000 Supporters of an Increase in the exemption point out that the number of estate filings increased 31% from 1907 to 1972 This sounds like a big increase but a look at some other data will help ut these figures in peispeetive There were roughly two million adult deaths In 1972 About 175,000 estates or 9%, filed estate tax returns (up from 7% in 1969) and only 121,000, or 6%, filed taxable returns. Only a quarter of wealth held 1y those who die each year is subject to estate tax J~bus 94% of decedents and 75% of all deced~nts wealth would not be affected by the increase in exemption. The 6% of de- cedents who would benefit are those with the largest net wealth since they are the only 4ecedents who are taxable Furthermore because the estate tax Is progressive, the absolute a!nount of benefit from any 1ncrea~e in the exemp tion increases with the size' of the estate, Effect of Propo8al The effects of a $200,000 exemption can be Illustrated as follows, The proposal increases the exemption by $140,000 Deç~edents with $60,000 or less In their gross estate (who are 94% of alt decedeuts) do not benefit since they are not subject to ~gy ~ow iJnder current law, a decedent with over $200,000 of gross estate and $140,000 of taxable estate Is in the 30% marginal ta~ bracket for g total tax of $32 700 A $200,000 exemption would completely eliminate this tax for a benefit to the heirs of $32,700 A decedent with a million dollar taxable estate Is just leaving the 37% margInal tax bracket The proposed reduction of tins taxable estate Is worth $140 000 times 7 or $51 800 Two-thirds of the $15 billion In total taxable estate for 1972 were In marginal brackets of 28% to 39%, so these three cases can be regarded as typical of the savings In the bottom two thirds of all taxable estates Although absolute dollar benefits increase with size in this way, It must be pointed out that the reduction of tax as a percent of tax liability or as a per- cent of the entire estate decreases with the size of the estate. It would be possible to enact a tax credit of comparable value that would give the same benefits to all estates with tax liability of at least the credit amount. Thus a tax credit of $20,000 Is worth nothing In the first case set forth above, and would be worth $20,000 in the second and third cases. This form of tax reduc- tion as a percent of tax liabIlity or as percent of the estate would decrease faster with estate size. In general estate taxes are Intended to prevent the massive accumulation of personal wealth. The purpose of the exemption `is to relieve certain estates from taxes. The amount of exemption, then, depends upon what society views as unusually large* personal wealth. Since most opinions `about the redIstrIbit~ tion of wealth have changed in the' last generation, we prefer a real exemption of $60,000 to a real exemption of $200,000. roan E8PATS ThX PROPOSALS We are also opposed to any Increase in the estate tax exemption for farmers or businesses Attached you will find an article by Brant S Goldwyn from PAGENO="0496" 482 Tar Notes, February 2, 1976 which analyzes in detail the Ford estate tax proposals. Mr. Cht~iru~an, that co~eludes my testimony, FQRD ESTATE PROPOSALS AZ'TALTRED (fly ]lrant S. Goldwyn) President Ford has proposed a change in estate taxes that he claims will help preserve family ownership of small farms and businesses. For estates worth $300,000 or less, all estate taxes would be postponed for five years. The estate would then have 20 years to pay the tax, plus interest at .4% a year. The benefits would be scaled down for estates Over $300,00; estates exceeding $600,000 would not qualify for thIs plan. The Administration claims that the family farmer and the small business- man are prevented from passing thCir business on to their heirs because of burdensome estate taxes. The argument is that, because of Inflation, small businesses which formerly escaped by the estate tax are now worth much more on paper, without a Corresponding increase In ` earning power. Their aspects are mostly in the il-liquid form of land, buildings and machinery, rather than stocks or bonds. This is referred to `as the "liquidity probiSm." The only way that sufficient cash can be raised to pay' the estate tax on the business' inflated value Is to sell the entire farm or business. Such "forced" sales supposedly run against the grain of a society which enshrines the independent small business- man and the family farmer. ~ubatantiaZ Liberalization Under current `law, Section 6166 of the Internal Revenue Code permits pay- ment of the' estate tax to be made in installments over 10 years for a qualifying "closely held business." Interest due is 7%, The Ford proposal represents a substantial liberalization especially with the five year grace period ançl 4% Interest rate on the unpaid balance. While the admlñlstrátlon calls this a "postponement" of taxes and not a reduCtion, 1~be net effect has been calculated as a 45% reduction In estate taxes. (The value of deferral is equal to the interest that can `be earned on the unpaid taxes.) Are families forced to sell their business to pay estate ta~es~ Despite the rhetoric of the White House members of Congress and small business spokes men,, many experts believe that estate taxes do not have such an effect. For example, many agricultural economists and others do not feel that "forced' sales" of farms Is a problem. Studies of Iowa farms `showed that most estate taxes were paid without selling any substantial part `of the farm, tinited States Department of Agriculture economist Fred Woods, writing on this subject in 1978 and 1974, concluded that, while farms were paying more estate taxes, death taxes were "not yet a serious problem for most types of farms," and "were not unduly oppressive with respect to rural landowners. Woods said that what was needed by those farmers with a liquidity problem ~as "better~ estate planning within the framework of existing law rather than changes in the tax law." Liquidity Problems In many cases liquidity needs could be met by insurance. Smaller farms are protected by the current `estate tax deductions; larger firms usually had sufficient credit to refinance their property, Some of the farmland could be sold without making the farm too small to take advantage of ecnomles of scale. The Ford proposal offers maximum benefits for business worth up to $300,000, and partial benefits for those worth up to $600,000. Certainly, an intuitive definition of wealth would not consider someone with a $300,000 estate to be poor or In need of federal assistance. It is true that most farm estates are not liquid. In 1t~70, 78% of farm assets were in land and machinery, according to" USDA figures, versus 22% of the value of all estates filing 1970 estate tax returns. But a farm worth $300,000 Is not a small farm. According to United States Department of Agriculture calculations, the average farm as of January 1, 1974 had assets of $168,000 and a net equity of $142,000. USDA divides farms Into a different classes (ac- cording to amount of sales. Only Class TA, with annual sales, (not assets) over $100,000, had an average net equity in excess of $300,000. (Sep Table 1) PAGENO="0497" 483 tABLE I Class Sales Numb~r of farms Percent of total farms Average Maximum Average Estate net eState estate size (thou. equity tax tax paid sands) 6....~.. Under $2,500 5 $2500 to $5 000 4 $5 000 to $lb 000 3 $1b,000to$2b,000 $20,000to $40 00C~ lB $40,000 to $10b,000 1A~ Over $100,000 101,000 494 000 Z4S~ 000 325000 588,000 355, 000 115, 000 25 17 9 12 21 12 4 $44,000 61,000 79,000 $1 600 $480 $70-$80 117,000 8750 4,500 $100-$120 177,000 ~25, 800 11,050 $1504200 281 000 57, 000 23, 930 $~00-$300 685, 000 189 450 116, 180. $500-$t, 000 Sourcq: Data up through column on average net equity of farms is from the U.S. Department gf Agricqiture aod r~fIects year of 1913. Remainder of data is from 1972 StatistIcs of lnco~he, Estates,~publlshed by the Internal Revenue Service~. While IRS figures don't Indicate how many taxable estates included farms or other businesses, the above figures IndIcate that the average estate tax Is not a large percentage of smaller estates. Of the $4.7 billion collected from the estate tax in l9~3, only $86 nillUon, less than 2%, came from estates valued at $120,000 or .l~ss. Alhiost 50% of t1I~ estates that filed estate tax returns were worth Sunder $120,000; 63% of V.~. farms fit into a class where averEtge equity Is below $120,000. The bulk of estate taxes were collected from estates worth over $120,000. Farms in classes 2 and 11~v wilh an average net ei~u1ty of $177,000 and $281,000 respectively, would get the full benefit of the Ford prOposal, even though they are iu the wealthiest third of 17.8. farmers. It thus appears that any estate tax savings *ould go mainly to farmersthat already are well off. Comparable flgtzres on the a~erag~ equity of iIou~farni bu~lnesse~ don't seem to be available. CorporatIons won't be discussed since they don't pa~~ estate taxes. According tO the IE~, fOr tax year 1971, there were approximately 10 nililion sole proprietorships, but no asset figures are available for 4his category. IRS does have some figures on "partnership" assets. Table 2 shows the average gross assets for partnerships. These ~lgures actually overstate the value of such busi- nesses for estate tax purposes. The estate tax is paid on net assetS, which Is gross assets minus, liabilities. More(yver, since these figures are for partnerships~ any one parimer would own less than the entire business. Thus, a partnership with gross assets. of $100,000 may have l!abilltles~ of $10,000 and be equally owned by two partners, so that each partner's equfty would be $45,000 ;. $45,000 `wouldbe izicluded its the grbSs :estáte of each partner for estate tax purposes. ~IutZZ Eugia~~ 1~JizUsUcs . The fo~Jow1ng Thble 2 sbows that 73% of all part~nersIlps i~ 1971 bad gross assets under $100,000. Therefore the White flou~e proposal, with maximum benefits for estates of $aöo,000, woiild : aid most partnerships, not just the Smallest. TABLE 2.-N01'4FARM PARTNERSHIPS-197l cross assets (in thousands) Number of Percentage of Cumulative partnerships partnerships percentage - 0 $1 to $10 ~ .,.. $10 to $~5 ~ $25 to $50 $50 to $100 $lOOto $250__._,______.._~~__, $250 to $500._____________.,,___,___,_____ $500to$1 000._~__~__.~,, $1,000 to ~5,000 Over $5,000 . Total 58000 104 104 111,500 19.9 30,3 83, 000 14.8 45.1 79, 000 14.1 59.2 7~,600 13.8 73.0 74,200 13.2 86.2 34,200 6.1 92.3 20,700 3.7 96.0 19, 000 3.4 99.4 2,900 .5 99.9 560,000 Source: IRS Statistics on Business ln~orne Tax Returns, 1971. The likelihood that an heir wOuld want to contthts~ the family bn~ln~~s Is lower in a non-farm sitUation. The heirs often lack~ either the Interest or the entrepreneurial skill needed to maintain tJ~e btfsine~s, Sale Is therefore a prob- able result of the owner'~ death no matter what. the estate taxse are. More- over, one. accountant fe~t that small businesses wbi~h were, Sold uguall~ were purchased by other small operators. 68-872-76--.----82 PAGENO="0498" 484 Treasury estimates the revenue loss from the White House proposal to be: 1st year-$2.5 million, 5th year-$12.5 mIllion, 10th year-$19 million, decreas- ing thereafter. Loss of interest from the lower rate would be: 5th year-$2.5 hilllion, 10th year-$5 millIon, 25th year-$10 million. The two figures should be added to give the total revenue loss for any year. The estimate reflects the difference between present law and the new proposal and does not include the costs of the present 10-year deferral provisions, Opposite Effect Po~sibZe Returning to the farm situation, a 1975 publication by the University of Illinois suggests that rather than help the small farmer, proposals like the President's may actually do the opposite and Increase concentration in the farm sector. Several conclusions are relevant: 1. If part of a farm must be sold to pay estate taxes, the acreage may be attached tO an undersized unit and add to its efficiency. For agriculture as a whole, there may be no net loss of efflciency. 2. Some division of large holdings may improve equ~llty of opportunity for those desiring to enter farming. Any concession in favor of current owners works toward. moving of land into the hands of a separate landowning class. Granting. greater latitude in paying death taxes would act to keep farming In somewhat larger units than would otherwise prevail. 3, The heirs frequently are not operating farmers. 4. Selective concessiOns for agricultural estates, such as a preferential va]- uatlon or estate tax exemption, would attract well4o-do non farmers and tend to transfer. ownership and control away from operating farmers. Moreover, to apply these preferences only to "qualified" farmers could result In overwlielim ing and costly administrative problems. For instance, making resjdency on the farm a condition might actually eliminate some bona flUe farmers According to Fred Woods of the ~tSDA, only 72% of farm Qperators reported living on their farms less than five years. Thus, such an approach may not be feasible to help the "family" farmer, Uongressional Proposals Congress has expressed great interest In estate taxes and many Ideas that could go further than the White House have been suggested. One popular pro- posal has been to raise the general estate tax exemption, from $60,000 to $150,000 or higher. The revenue loss would be substantlal-$2 billion if the exemption were raised to $200,000. Most of this nioney would go to the wealth- ievi people in America Another proposal would be special breaks only for farmers, such as raising the exemption or lowering the land value assessment. As discussed by the University of Illinois this would encourage non farmers to Invest in farming for tax shelter purposes. Furthermore, giving special con- cessions for farmers, but not for others with estates of similar sizes, clearly violates the principle of equity. Some economists believe that It would retard the highest and best use of land, An alternative being considered by Sen. Packwood, R-Oreg., member of the Finance Committee, would be to substitute a credit for the not yet proposed estate tax exemption. This would give equal monetary benefits to estate tax- payers at all income levels, rather than an exemption, which Is more valuable to wealthy taxpayers. Such a change would be more equitable. The amount of the credit depends on one's view of who should pay the estate tax. Pack- wood is considering a $25,000 credit, which would result in no tax on estates up to $114,000 and an estimated revenue loss of $400 million a year. Other Issues While the effect of estate taxes is debatable, there are changes proposed that clearly seem desirable. Current law does allow the state tax to be postponed over 10 years. Unfortunately, many estates don't do this because of certain restrictions. The executor of the estate is personally liable for the tax, and a costly bond must be posted. The alternative, supported by Treasury and others, is to substitute a lien on the Illiquid assets, the farm or other property, for the bond and the executor's personal liability. Interest rates on deferred taxes now will be tied to the prime rate rather than being set at a fixed rate. Interest had been at 9% on February 1 it became 7% Ibe Ford proposal of 4% seems to be subsidy. for those w~o defer estate taxes. Any rate substantially below market rates will encourage people to postpone estate taxes. As a corn- PAGENO="0499" 48~ promlse~ some h,~ve proposed to c11ar~e the rate that the7 ~overumeut ~ it borrows money, currently about 5%.. WMIi fajrer, this ~tW involves a SUb~ sidy to people deferrth~ estate taxes. It is tali~ to allow est~~te taxpayers to defer taxes, to give them more time to raise the money, but a low interest rate does ilot seem necessary. ~he `Treasury's 1969 Tax X~eform Study sup~ ported setting the interest rate at a neutral level which doesn't penalize or 5ub~ldlze who defer taxes. There are other Issues concerning estate taxes which, were not touched by the White House; The most controversial is the failure to tax capital gains at death. This costs the government over $15 billion a year. As a matter ~Yf equity, capital gains at death should be taxed. Once this is done, other changes in the estate tax, such as reducing rates or instituting a tax credit, might be ap- propriate. While some spokesmen claim that taxing capital gains ftt death would do in the small bu~1nessman, the fact is that most of the revenue gain would come from the wealthiest taxpayers, The University of Illinois' study suggests one result might be to reduce land speculation and investment by non- farmers by bringing the value of farmland more in line with its Income pos- sibiUtles as a farm rather than for speculation. The lower tax rates on capital gains Is more attractive to high Income investors. Maritai Deductioa Another facet of the estate tax which touches on the small businessman &s the marital deduct1o~. Currently this is 50% of the estate, so~ that the in~ heriting spouse pass no tax on e~tates worth $120,000 or less. The 19~9 Tre~ts- ury study ~tated that ti~añiifers betweeli spouses are not appropriate for tax- ation, especially where the surviving spouse has minor children. TILe policy could be either to increase the ma~rltal deduction or to in~ke It 100% and not tax such transfers at all. This obviously would help maintain the status duo in a farm business ownership. Small businessmen are hurt by 9tller parts of the tax eo~Ie. Farm shelters are attractiye investments for w~1i-j~o-4o nonfarmers who are allowed to write off current farm expenses against zion-6rm income. This drives up the eo8t of land axid other materials used by farmers and 4~presses the market for their goods. Small businessmen, whose companies may be more labor Intensive, can't use the investment tax credit and other provisions des~gned~ to encourage business. Mr. Piiui~. Thaul~ you very much, Mr. Reese, [The following ~t~tements were subsequently submitted on behalf of Taxation With Repr~sentation:] STATEMENT o~ J0EN K. McNUurY,~ Pnorzason~or tAW, VNTvERsIrr~ C~u~ ~oRNzA, Bxnxntar, CALIF., ON BEIXALr or TAxATIor~ Wn~n Rsiar~JwrIoN SUMMAR~ 011' BTATzMzNT Reform of the Federal Estate and Gift Taxes could best be achieved by re pealing tb~se taxes and at the same time making gifts and inheritances tax- able as income, under the Federal Income Tax. The reiiult would be a fairer tax, one geared d~reetly to the ability to pay of the person who receives the `JohnE. McNulty is a Professor of Law at the University of Cal1forn~a, Berl~oIey, School of Law (Boalt Hall). He received his A.B. degree froni Swsrthmore College in 1956 and LL.1l, from the Law School of Yale, University in 1959 During 1959 tbropg~ 1960 he served as law clerk to Mr. Justice Hugo L. Black of the ii~S. Supreme Court. EIe then practiced law in Cleveland, Ohio from 1960 to 1964, when he took a Oosition on the law faculty at the University of California, Berkeley, where he has remained until tills time. He has served as Visiting Professor or Law in Summer Sessions at the University Of Texas Law S~boO1 and Hastings Law Scb6ol. For a time, he also was "of Counsel" to a major international la~w firm. Professor McNulty has published a number of books and articles on venous tax sub~ jeets. Among them are MeNulty, Federal Estate and Gift TaxatIon (In a Nutshell), West Publishing Company, 1973; t~ragen and MeNulty, Federal Income Taxation (CaSes and Materials), 2nd edition, West Publishing Company, 1974; McNulty Federal Income Paxa- tion (Iti a Nutshell), West Publishing Company, 1i~72. His other publications include "Tax Policy and Tuitiop Credit Leglsl~tion: Federal Ipeome Tax Allowances for Per- sonal Costs of Higher, Flducation," 61 California Law Review 1 (1978). In additiOn to his private practice and consulting with law firms, Professor MeNulty has also served as a consultant with a number of govern~nent and private agencies, including the Call. forilia Constitutional Revision Commission, the California Legislature's Tax Reform Group, and The Rand Corporation regarding tax and other matters. PAGENO="0500" 486 gift or bequest. It would result in a simpler tax system, and one that would be less costly to comply with and to administer. In addition, the revenue yield and the equity of th~ federal income tax would be improved by including in it~ base gifts and lhheritances which in fact are items of income aifd shOuld be taxed as such. Therefore, I recommend that § 102 of the Income Tax be repealed or amended in such a way as to make property received by gift, beqe'u~t, devise or inberi tance included ~vithin the definition of gross income, under § 61(a) of the In- come Tax, with appropriate averaging provisions and supporting legislation as nece~sary. DISCLAIMER The following statement is solely the responsibility of the author. `It should not be construed as representing the views of the University of California or its School of Law at Berkeley or of Taxation With Representation. STATEMENT My name is John K. McNulty and I am a Professor of. Law at the University of California School of Law, Berkeley, California (sometimes familiarly known * as Boalt Hall). I specialize in teaching and researching the subjects of Federal Estate and Gift Taxation, Federal Income Taxation, International Taxation and Tax Theory and Public Finance I am presenting this statement at the invitation of "Taxation With Representation." I am ~ot affiliated with, or sponsored or `acting at the behest of, any private firm or organization and am speaking on my own behalf. ~impZiflcation and Estate and Gift Tae' Reform The proposal I should like to; put before the Committee Is one whose principal characteristic, and principal virtue, is its own simplicity and the simplification effects it would have on the Federal' Tax laws. Bather than amending the present Federal Estate and' Gift Taxes so as to cure some of the particular detects often noted in these laws, which amendments or reforms would be iil~el3r to make The lnw `more complex in an effort to make it `mere fair or more effective, my' prOpOsal ~ons1sts maialy Of' repealing existing laws,' as described in the following paragraphs. Tacoation of Gift and Inheritance as Income; Repeal of the Federal E8tate and Gift Tacoes I urge the Committee t~ cOnsjder the following structural reform as a means of simplifying and improving the taxation of gratuitous transfers of wealth at death or by lifetime gift. The proposal consists of repealing § 102 of the In- ternal Revenue Code of 1954, as amended, which excludes property acquired by gift, bequest, devise or inheritance from the Federal Income Tax law's definition of income, and also repealing (or radically reconstituting) the Federal Estate and Gift Tax laws. The result would be to tax inheritances and gifts as income to the recipients, under income tax law. This proposal, in its basic form, would not add anything to existing law on the bOoks, but instead would repeal a great many sections of the Internal Revenue COde, `compre- hending the Federal Estate and Gift Taxes as well as most or all of § 10g. Some amendments in the income tax law probably would' be necessary, how- ever, to deal with particular problems to which I will advert at a later point in this statement. Why Tao, Gifts and Bequests As Income? Why should the recipients of gifts and Inheritances be taxed on those re- ceipts as income? One answer lies in the fact that gifts and Inheritances do constitute Income to the receipients, both in an economic and in a legal and Constitutional sense of the word "income." Economists have long defined in- come as any accretion to wealth or any net receipt, The famous Haig-Simons definition of income defined income as the algebraic sum of (1) the market value of rights exercised in consumption and (2) the change in the value of of the store of property rights between the beginning and end of the period in' queation. This means that property received by gift or bequest is Income since it can be spent or, If not, will increase the net worth of the recipient. See H. Simons, Personal Income Taceatlon, pp.. 56 if., and pp. 134 if. (U, Chi. Press, 1938). PAGENO="0501" 487 Judicial ~eflnit~lons of "li~come" as used in the 16th Amendment and In § 61(a) of the Internal Reyêuue Code have gradually expaüded the concept of income to the, point thnt It now includes any instau~e. "of undeniable accessions to wealth, clearly realized, and over whjch the taxpayers have complet~ do~ minion." See Com'r v. Glenshaw GlasS Co., 848 u.S. 426 (195~). Thus, to eeo~i~. oinists ançl to persons in the street, property received by gtft or inheritance represents additional power to save or to consume and thus amounts to "in~ come" in both the technical and the everyday, sense oi~ the term. Mgreover, recent and resp~tisthle tax reform proposals have recommended that the `income tax include gifts and bequests. See, e.g., 8 Report of the Royal Commission on Taxation (The Carter Commission Report, Canada) 1966, Ch. 17. For a great many years, gifts and inheritances have been excluded from the Federal Income Tax'~ definition of gross income by statutory exclusion, presently found in § 102 of the Internal Revenue Code. The exclusion may historically have stemmed from a fear that the term "income" as used in the 16th Amendment did not comprehend gifts and inheritances, but rather was limited, in the language of early Vnited States Supreme Court opinions, to "gain, derived from capital, from labor, or from both combined." See, e.g., Doyle v. Mitchell Th~os. Co., 247 U.S. 179 (1918), quoting frora Stratton's Inde- pendence v. Howbert, 281 U.S. 899 (1913). ~he exclusion for gifts and Inhertt- ances has contintied beyond the time when these constitutional doubts have receded, for a variety of reasons. One reasor~ may have been to "keep the Tax Commissioner out from under the Christmas tree." That is to say, c~hsidera~ tions of administrative expediency and psychological factors and matters in~ volving ability to pay may have suggested that the receipt of a gift or bequest should not be a taxable event. Another reason that the income tax has been content to exclude gifts and inheritances undoubtedly lies in the fact that such transfers were taxed by the Federal ~state and Gift Taxes, the transfer taxes that form a part of the federal tax system. Those transfer taxes, in turn, provide substantial exemptions or annual or lifetime exclusions, os that birtb~ day gifts and Christmas gifts and other small transfe~s need not be reported. Larger transfers sometimes must be reported, though no tax need be paid. And only transfers that are quite significant in amoUnt are stibject to reporting and to tax. Repeal of the Federal Estate~ and Gift Taxes would lead to ye- consideration of the exclusion contained~ in the lneom~ tax la~v. M~ suggestion starts from. the other direction and suggests repeal of § 102, which would in turn imply repeal of the federal trami~fer taxes. What Are some of the Advantages of Thcifing Gifts and Ee~m~ats as tn~ome? To tax gifts s~ii4 ~bequests as income would be to ~xpand the base of the in- come tax and to comprehend In that tax, with its graduated rates, annual computation, and other structural `characteristics, items of accretion to net Worth That belong `in the L~a~ of the income tax because,, just as munch as income earned from person efforts or ir~vestments, such items do provide finan- cial gain to the receipients and increasa their ability, to p~y tax. To tax the receIpt of, gifts and bequests as, Income changes the ,i~entlty of the taxpayer., from, our prese~t system. `Und~* present Federal transfer tax, the donor of a lifetime, gift or the decedent who transfers property at death is the taxpayer. The t~x c~wlng, is computed by measuring the amount of the gift, in conjunction with otimer gifts made by the taxpayer during life or ~t death, and imposing a tax upon this base, subject to certain exemptions and exclusions. In other words, the amount of tax owing is measured `by the ca- pacity of the donor to confer a gratuitous benefit upon the donee. State in- heritance taxes have much the same characteristic, although the rate of tax more often. varies with the identity ,of the recipient, with higher rates of tax being applied to transfers mx~ade to unrelated persons or more distant relatives, and lower rates applicable to transfers made to a surviving spouse or dependent children, for obvious reasons of social and economic policy, as well as equity. The proposal to tax gifts. and Inheritances to the recipient rather than to the transferor means that the amount of tax paid will be geared to the tax- paying ability of the recipient rather than that of the transferçr and would be determined by the income tax rates an~l other rules, rather than the rules of the `Federal Estate and ~ift Taxes. In some respects, this proposal resembles the proj~osal for an "Accessions, Tax,", which, however, would determine the amount of tax owing by the recipient according to the amount of donative transfers received by that person during his or her life, without regard to the other income or wealth of the recipient. PAGENO="0502" 488 The proposal that gifts and inherltanc~s be taxed as income, to the recipient, would adjust the tax owing to the ability to pa~~r ot the recipient taking into account that recipient's income from all sources. This pr~osa1 has the ad- vantage of fairness, at least to those who view the federal income tax as the ftfrest tax in tim federal taxing system and as one that somehow gets at ability to pay better than any other tax, whether at the state or local or federal level (except perhaps a theoretical wealth or expenditure tax, or a hypo- thetically comprehensive and all-Inclusive income tax, none of which is ad- ministratively feasible or likely to be enacted in the foreseeable future). Another advantage consist of the fact that the rate of tax on gifts would be the same as the rate on bequests, which would be a ehgnge from the dis- parity in rates of the present transfer taxes, a disparity that gives rise to much tax planning, controversy and administration and compliance costs. Still another advantage may lie in the redistributive effects of the proposal. Although it would be premature to advance a definite conclusion about dis- tributional effects, a likely surmise would be that taxing gifts and bequests as income would lead to less concentration of wealth and wider distributions of property given during life or at death, and to lower income taxpayers, com- pared to the effects of present transfer taxes. What Ar~ some of the Real, or ~upposcd, Disadvantages of Taving Gifts and Inheritances an Income? What ~Solutionn May Be Found? `One supposed disadvantage of taxing gifts and Inheritances as income is that a taxpayer might, once in his or her lifetime, receive a large gift or bequest all of which would be taxable in one year and subjected to the graduated rates ~f the income tax law. If this were to happen, the result might be to put a very heavy tax burden on such a recipient compared to someone else who receives the same amount in gifts or inheritances over a number of years, and thus is in much the same overall position as the first taxpayer. Or It might be too heavy ~vhen compared to the burden on a' third taxpayer who has income from other sources but that income is spread over a period of years and thus tax- able at lower marginal rates than it would be if lumped within one year. The present answer to the "bunching" argument lies in the provisions of the Internal Revenue Code which allow "income averaging" over a period of five years. If gifts and inheritances were taxable as income and also made eligible for sneh averaging, the problem of the bunched receipt in one year would substantially be ameliorated. If the present income averaging rules were not i~egarded as sufficient for this purpose, more extended~ averaging might well be afforded to gifts and bequests, or the present income averaging rules themselves might be extended to cover a' longer period of time. Another possible disadvantage of taxing gifts and inheritahces as income might be thought to be the necessity of reporting birthday gifts and holiday transfers and mdnyother small exchanges that would heavily burden the tax- payers to report or which would largely go unreported and thus untaxed. The answer to such an argument is to Include in the income tax law an annual exclusion or a lifetime exclusion of a certain amount. As a result, the tax' authorities would not have to `~s1t beneath' the Christmas tree" or make liars out of taxpayers who inadvertently or otherwise failed to report the small transfers that take place, particularly within a family context, and which are not presently taxable under the rederal Gift and ~state Taxes. The addition of some special exclusion or exemption in the Income tax law would be to in- jedt a small additional complexity in that law. However, the benefits derived in the form of repealing the lengthy Estate and Gift Tax laws and imposing a fairer tax on donative transfers and improving the integrity of the Income Tax itself by extending It to an item of income that for many years has been exempted, more than outweigh the slight disadvantages In amending § 102 and possibly the income averaging provisions. It is likely that some additional statutOry enactments would be necessary In order to cope with the multifarious apd complicated transactions that tax- payers have learned to construct as ways of minimizihg or avoiding the present federal `transfer taxes, the Estate and Gift Tax laws. Serious thought would have to be given to the problem of trusts, revocable transfers, gifts disguised as loOiis, transfers with retained powers of alteration or amendment, annuities, life insurance, powers of appointment, future interests and the many other problems dealt with by §1 2033-2042 (and beyond) of the Estate and Gift Tax law' and §1 2511-2524 of the Gift Tax law. It wOuld be overly optimistic to PAGENO="0503" 489 imagine that those transfer taxes could be repeaie4 and nothing sub~titnted for them when gifts and bequests are made taxable as income. However, the nature of the new structure-the taxation of gifts and bequests as incothe rather than as transfers taxable to the transferor~-would uieau that the legis- lation necessary to prevent escape or undue deferral or shifting Of tax would h~ les~ expensive, as would the administrative promulgation of regulations and the enforcement of compliance under present law. Some other questions undoubtedly will arise, such as whether a special ex- clusion should be afforded to surviving spouses or children. These and other similar questions can be analyzed and answered, but for present purposes are left unanswered. Problems of "what's gift" or bequest exist now because of the exclusion in § 102, just as they would If gifts were taxable as incomC. Many of the other implications of the proposal are examined In Chapter 17 of the Carter Commission Report, mentioned earlier. Preventing Tam~ Avoidance and Unfairnes~ The Federal Estate and Gift Taxes are well known as taxes that need not be paid, if competent tax advice is available, or whose burden can substantially be minimized by clever (and perfectly honest) tax planning. The result Is that they are taxes that produce very little revenue and taxes whose burden falls quite unevenly upon taxpayers in similar positions, depending upon their ability to obtain and use tax planning advice and their capacity for engaging in intricate or tax-shaped transactions, sometimes at the expense of what they seek to accomplish as a personal or financial or economic matter. The costs of complying with the present transfer taxes, or avoiding or minizmiling them, are very substantial; they support a whole industry of tax advisers (lawyers, aecountaints, bank trust officers and others) and involve the Internal Revenue Service and taxpayers In a great many hours of planning, record-keeping, com- pliance and administratiOn. The Federal courts are tied up with ta~ eases and the state probate and other courts wfth cases whose principal purpose Is to produce a desired Federal tax effect. Private dispositiOns of wealth are de- terred or accelerated or otherwise distOrted by the transfer taxes. While a sys- tem of taxing gifts and inheritances as income would not be fully free from these compliance and administrative costs, it Is very likely that the costs would be muck lower. Revenue L088e8 or Gain$? Estimates of the revenue gain or loss that would result from the proposal to tax g1ft~ arid Inheritances as income are not reliable and readily available. However, the amount of revenue raised by the present federal death and gift taxes can be calculated and Is known. The revenue loss from the "tax expendi- ture" resulting from the failure of the income tax to tax gIfts and bequests can be estimated, by the procedures used in the so-called "Tax Illxpenditure Budget," such as that provided for the Committee on Way~ and Means and the Committee on ~inance by the staffs of the Treasury Department and the Joint Committee' on Internal Revenue Taxation and dated July 8, 1975. The Tax Expenditure budget of that date did not treat the exclusion of gifts amid bequests as a tax expenditure, though quite properly it might have. Professor Surrey acknowledges that the exclusion could be listed as a tax expenditure and that most econQmisfs would so list it, but states that at present mOst people's concept of income does not 1nclud~ gifts and bequests, though ~he economists' definition might come to be accepted. See Surrey, Pathwerys to Ta~r Reform, p. 18, p. 28~ at n. 6, (Harv.U.Press, 1973),. In any event, the methods used for estimating federal tax expenditures, as the critics of a tax expendi- ture budget and the Treasury Department itself have agreed, are In some ways Insufficient. Most particularly, If gifts became taxable as income, It is possible that either fewer and smaller gifts or more and larger gifts would be given, as a result of the incentives or disincentives created by repealing the Estate and Gift taxes and repealing the exclusion in the income tax. Therefore, to compute the revenue loss is not sittmply a matter of looking to see the amounts that were given by inter-vivos gift or bequest under the present transfer taxes and then attributing them to certain classes of donee taxpayers or an average donee taxpayer and estimating the amount of revenue that would result if the income tax rates, rather than the~ death and gift tax rates, bad bOen appli- cable to the amounts transferred. Nevertheless~' tax expenditure* analysis is PAGENO="0504" 490 one means of making some estimate of the amount of revenue loss or gain that would result from the structural change suggested here. Conclusion The structural reform that would result from taxing gifts and bequests as income to the recipients and repealing the transfer taxes on decedents and lifetime donors would produce a simpler federal tax law, a tax law less costly to administer on the part of the government and to comply with on the part of taxpayers. It woud pro~tuce a fairer tax, because it would coordinate the tax burden With the ability to pay of the person upon whom the tax is im- posed. At present, It is impossible to say who bears the burden of the Federal Estate arid Gift Taxes, because no one can identify who would have received the funds that are paid in death or gift taxes to the 1~'ederal Government. Those funds might have been consumed by the decedent or donor during life, they might have been given to the beneficiaries who did receive some gifts or be- quests (after taxes), or they might have gone to still other beneficiaries who were cut out of the will or gift-making scheme of the donor because of antic- pated transfer tax liability. If gifts and inheritances are taxed as income, the burden of the tax collected from the recipient certainly would seem to fall upon that recipient and no one else. In some complicated ways, economists may suggest that the burden will have effects on other people, because the taxes paid by the recipients will reduce their own ability to consume or to save and invest and thus will have effects not only on their own welfare but also on the people who would benefit from the savings or consumption by the recipients of the funds made unavail- able by the income tax. In this complicated sense, the income tax always has allocational and recilatributive effects of a secondary nature. Putting them to one side, it would seem clear enough that the burden of the tax would fall upon the nominal taxpayer, the recipiept of the gift or bequest. The amotnit of the tax would be geared to the income of the recipient, per- haps averaged over a five-year period or a longer period. The Income of such a recipient may not be a perfect measure of that person's ability to pay tax, but it seems to be the best measure our tax system has yet given us. It will be made still better by including in it, gifts and bequests-the items here at issue. One of the defects of the present income tax in its measuring of ability to pay is its failure to include property received by gift or bequest In the tan base. Therefore, a taxpayer's rather small amount of earned Income can be taxed at low rates even though he or she also has. received, in that same year or in. other years, v~y large amounts of property by gift or bequest. The result is that the income tax is less fair than it would be if gifts and bequests were added to the base of the tax. Consequently, the structural reform as here suggested, one that would tax gifts and inheritances as income and not as transfers by the donor or decedent, would not only simplify the ~federal tax structure and reduce the cost of ad- ministration and compliance, but would also produce a fairer taxation of gifts and bequests themselves and furthermore a fairer taxation of other items of income, the tax rate applicable to which would be affected by the amount of income received in the form of gifts and bequests during the year or the aver~. ageable period.. The structural form proposed, here can be view as part of a larger package, In which the base of the Inconm tax would be expanded and made more com- prehensive, the rates perhaps changed to a different graduation or. to a pro- portional~ rate system, the payroll tax repealed, or governmental benefits . such as Social Security and Welfare payments either eliminated or made taxable, and if eliminated then replaced by a negative income tax or other guaranteed annual income or "clemogrant" plan, integration of the personal and the corpo- rate income taxes and other changes. There Is s9me relationship between the proposal made in this statement and other parts of this broader tax reform package. For example, if the income tax were a proportional, tax, the taxation of a bunched gift or inheritances In a particular year would not produce ~t ~igber tax bill than would have followed if the gifts and inheritances had been received over a period of years or In some other form. In other words, adopting a `proportiOnal rate system would remove the incentive on the part of tax- payers to shift income from one year to many years or from a, high tax year to a low tax year. Income averaging would become unnecessary. However, the PAGENO="0505" ~:>~ 49'~ proposal made now, to t~ ~fts a *~ eritanees as * Income; can be adopted without adoption of the other dtn~iensions o~ the structural reform proposal I have alluded to. ~ ~ ~ ~ I hope that the Treasury Depaitment will see fit to give further attention to this proposal to provide estimates of revenue loss or gain nuder various alter native constructions and to work out the legislation necessary to iniplement the proposal ançl to safeguard it against abuse or evasion, much as the Federal Estate and Gift Tax laws now deal with transactions not foreseen at the time original and much simpler gLtt and estate tax laws were enacted I should like to thank the Committee for this opportunity to put forward a ma3or, structural proposal I stand ready to provide any further statement or testimony or as~ist~nce that might be thought desirable STATEi~ENT or ST~NLEy S. Svnnn~v,1 Pnornsson ox LAW, HARVARD LAW ScHooL, SOMMARZ GF STATEMENT Estate and gift taxes are lit need o~ cothplete revision~ The Committee should hdire its staff provide data on the distribution of wealth In the trnlted States, by total net assets and types of assets Without these ~Lata consideration of transfer tax iSsues Is um,ealistic. The imporant needed structural changes involve: Unification. of the present g1f~ ta~ and estate tax into a unIfied transfer t. Adoption of provisions whith wotild end the present escape from tax of thier famIlies throngh~"generation skipping" transfers. (3) Au Inersase in the mdrit~l deduction. (4) An end to the very large escape of appreciation In asset value from in come tax in the case of assets transferred at death, the solution being the liii positioh of income tax at death on the appreciation with a deduction of the tax from the gross estate. The transfer tax exemption level should be lowered-not increased-since appropriate relief is given the surviving spouse through the' marital deduction and appropriate relief can be provided for dependents, Transfer tax rates should start at a higher level than at present and the progression made more rationaL EEVX5ION Or TIlE FEDERAL ESTATE AND GITT TAXES This statement will first briefly describe the present structure of the federal estate and gift taxes in the United States and then consider the sigrnfieant current policy issues respecting those taxes, I. Present Federal Estate and Gift `Tawea The federal estate tax Is levied on the, transfer of the estate of a citizen or resident decedent and Is structurally an estate tax rather than an inheritance or accessions tax The taxable estate consists of the world wide gross estate of the decedent less the allowable exemption and deduetions~ The gross estate includes all assets of the d~cedent held at death plus transfers during lifetime which are regarçled as incomplete because of any interest retained by the de cedent-e g i evocable trusts, transfers with a retained life estate-and copi pleted transfers made within three years of death if made in contemplation of death The deductions include debts of the estate, transfers (without limit) to charitable organIzatIons and property transferred to a spouse (the so called marital deduction) under conditions that the property will either be consumed by the spouse or includible in the spouse's estate and subject to a limit of one half the gross estate after subtraction of debts The exemption is a fiat $60 000 Thus, a net estate of $120 000 left t~ a spouse is free of tax-$60,000 cx emption and $60,000 marital deduction. The rate schedule starts at 8% of the taxable estate rIses rather rapidly to 30% at $100,000, to 39% at $1 million, 07% at $5 million and a maximum of 1 Stanley S. Surrey is a rrotessor of Law at the Harvar~ taw School, He was Assistant Secretary for Tax Policy in the Treasury Department in 1961-1969. PAGENO="0506" 492 11% at $10 thillion. The rates are applied to the full value of the taxable es- tate, including the amount needed to pay the estate tax itself. Credits against tlie estate tax are allowed for foreign estate taxes, United States gift taz on lifetime transfers included in the gross estate, and statq death duties to a limited extent. The federal `gift tax' is applied, on a cumulative basis, to transfers by gift during life. The rates are three quarters of the estate tax rates and are ap- `plied to the value of the gift but, unlike the estate tax, not to the gift tax itself -he. the gift is not grossed up. There is a lifetime exemption of $30,000 per donor and an annual exemption of $3,000 per donee. Only one' half of a gift to a spouse is Included. Also, If one spOuse makes a gift, the spouses may elect to treat the transfer as a joint gift; thus, $6,000 given in one year to a child by a father is fully exempt under this election. Gifts to charitable organiza- tions are deductible without limit. While the gift tax is cumulative, in that the taxable bracket of a current gift is determined by totalling all prior gifts this cumulation ceases on death and hence the' amount of completed lifetime gifts does not affect the estate tax bracket.' The two taxes are thus essentially' separate. The federal estate tax raIses $4,4 billion in revenue; the gift tax $.6 billion. Estate tax is paid by about 5% of decedents, with only .2% of decedents hav- ing taxable estates over $500,000; the latter account for 60% of the estate tax. While the total revenue of these transfer taxes is low in relation to other taxes (the alcohol tax yields $5.4 billion), the transfer taxes are leYled on the very wealthy and hence contribute to the overall progressivity ot the tax system Thus, to account for 60% of the income tax we woul4 have to cover returns over $18,000. or 18.8% of all income tax returns, as compared to the 4% of the estate tax returns. The United States has no national annual wealth tax. The Constitution re- quires that an annual wealth tax being a direct tax, would have to be apportioned among the states in accordance with population, Suck apportion- ment would defeat the purpose ot the tax. Therefore, unless Ingenuity finds a way around this barrier or the Constitution is amended (as it was to permit the income tax), the, United States 1~ not tree to enact `an annual wealth tax. Nence, the estate and gift taxes are the only national taxes on wealth. (There are state and local taxes `on real property and in some cases on tangible or in- tangible personal property),' II. ~Strueturaj The federal transfer taxes have remained essentially unchanged tor more than a quarter century. Elsewhere the federal tax scene is marked by constant and often turbulent legislative action, but there has been scarcely a ripple in the transfer tax field. Clearly taxes untouched for such a long period are prima fade in need of repair and the transfer taxes are no exception. Several i~ depth studies in the 1960s by the American Law Institute the Brookins Institution and the Treasury Department all point to the need for serious changes. The following is a brief description of some of the issues that should be considered in a major revision. Structural issues will be discussed first and then rate and exemption level issues. Unification of 0/I and Estate Taa'es.-~-A major Inequity in the existing estate and gift tax system is the manner in which the system favors `lifetime gifts over testamentaiy dispositions Whether lifetime giving should be favored at all is a matter that can be debated. But even ass~ming that' some favOritism should be shown, the existing system provides this favoritism in an irrational and inequitable manner. `j2he existing favoritism Is a result' of three separate factors. First, the exist- ing gift tax is calculated from a separate rate schedfile distinct from the rate schedule applicable' to the estate tax. Second, the gift tax rates are lower than the estate tax rates. And thir'd, the tax base Is different. Each of these fac- tore works differently, favoring different classes of donors In different ways. As ~wlll be shown, however, the net result' of' these factors i~ that, from a tax sav- ing standpoint, the larger the estate, the more `advantageous transfer by gift becomes. Since the taxation of gifts is based on a rate schedule completely separate from the estate tax rate schedule, total wealth transfers by an individual may be divided between lifetime transfers and testamentary transfers with each type of transfer taxed Independently on a schedule beginning at the lowest PAGENO="0507" 493 rates. The aggregate transferS niade by ~Lfl individual can thus be split between two i*te schedules and therefore 1~ed at rates unrelated to the individual's total tran~fers of wealth, The total tax will depend on how much of the total amount transferred is subject to the gift tax and how much Is subjeet tO the estate tax. Because neither the brackets nor the rate progressions Of tile estate and gift taxes are equal, the extent of this advantage ~var1es from 1~rac1~et to bracket. Once the maximum bracket is reached In the gift tax, there Is no further saving from this factor. }ience, the saving due to this aspect of the transfer tax structure Is limited for the v~ery largest estates. The maximum possible tax saving In absolute dollar terms that can result solely by reason of splitting transfers between gifts and testamentary transfers is $1,700,000 for those with an aggregate estate of $20,000,000 or more, This amount of sav- ing is solely that attri~utab~e to the splitting factor and assumes that the next two factorS discussed `t~re nOt present. The second, and perhaps most obvious factor favoring lifetime gift~ over death tran~fers is that gift tax rates are 25 percent lower than the estate tax rates in each bracket This factor appliCs equally to all Sizes of estates and, therefore, grants the satne degree of favoritism to gifts by all taxpayers. The third factor favoring lifetime gifts is that the tax bases for the estate and gift taxes are different. This factor is somewhat more subtle in its opera- tion and therefore Is frequently overlOoked, but for tile very wealthy It pro- vides the most sig~jflcant saving for lifetime gifts. The base to which the estate tax Is applied is the aggregate property owned by the decedent before diminu- tion by that tax, whereas the base for the gift tax is the net amount trans- ferred to the donee. Foi~ example, if a decedent leaves an estate of $10;000,0® to a child, the estate tax will be about $6,000,000 computed on the base of $10,000,000; the child will receive a net bequest of about $4,000,000. If on the ether hand, the same taxpayer decided `to make the maximum transfer l~e could make to the same beneficiary (using, for purposes of iblustratlon, estate tax rates for the gift tax as well in order to focus solely on this feature of the gift tax), he would `make a lifetime gift of roughly $6,500,000 and Incur a gift tax of about $3,~00,000, thereby consuming all of his assets. By transfering property during' his lifetime then, he would be able, solely because of the di~1er- ence In the tax base, to increase the net amount given to the beneficiary from $4,000,000 to $6,500,000, an increase of over 60 percent. This result obtains because the estate tax rates are applied to the aggre- gate estate of $10,000,000 whereas the gift tax rates are applied to the n~t transfer, which in this example is $6,500,000. To put it another way, the estate tax is jt~ppsed ozi the agggegate transfer before tax and the tax is then; "with- held" from it nltieh as income tax is withheld from the ~aggregate wages befOre tax of an individual. The gift tax, however, is imposed' onll oii an "after-tax basis" on the net transfer exclusive of the azhount of the tax itself;, again using the income tax analogy, the gift tax is Imposed only on "take-home pay." Where the tax bracket of the transferor is very high, the fact t~mt the. gift tax itself Is not 1n~luded. In the base makes an enormnus differenCe. ~3ecause tile tax rates tbemseTve~ lucrease as the size Of the transfers increase, the falipre to 4nelude the tax in the base, 1.0., the failure ~to "gro~s up," is of increa~in~. advantage as the aniouni of a transferor's assets increases,. 13'or ~x~tmp1e, a cedent leaving an. estate of $500,000 pays an estate tax of $145,000, therOby transferring $355,000 to his heirs. By diaposing of' his entire wealth by life- time gifts, he would,. solely by reason of~the failure of the gift tax to gross sip, increase the net amount pá~sing to the transferee to about $~75,ç~00, or an' in- crease of $20,Q00 ove' the net amount which would paas at death. This is an increase of less than 7 percent. On a $10,0O~,O00 transfer, bo~vever, th~ in- crease, as indicated earhi'er,~ woud be over 60 percent. (In the co~lctllatious ihade for illustrative purposes in all o4~ these examples, estate tax rates are also n~ed for the gift tax in Orde~ tQ isolate the et~ect of the failute to gross ut). The solution for this situation, included in the i96~-19ea Treasury Depart- ment Proposals for transfer tax revision, is "unlftcation" of estate and gift taxes. Under this prOposal the existing estate and gift taxes with their sepa- rate schedules wOutd be replaced by' a single unified transfer tax with a, single schedule of rates and exemptions. In determining the applicable tax rates `on property transferred. at~ death, all transfers made during lifetime would he taken Into. aceouut ~or example, if an individual made $100,000 in taxable gifts during lifetime and paid taxes on them and thereafter ~cft an estate of $500,000 at dehth, assuming no deductions or exemption, the tax applicable PAGENO="0508" 494 to the $500,000 transferred at death would be com~nted at the rates beginning above $100,000. Stated differently, the lifetime and deathtlthe transfers would be aggregated so that the total tax at death would first be computed on $000,- 000, an.d then the amount of transfer taxes paid during lifetime would be credited against the tentative tax so computed leaving the balance as the tax due on the estate. Another aspect of this proposal is that in computing, the tax on a lifetime transfer, the transfer would be grossed up so that the lifetime transfer tax `would be computed on the same tax base as deathtime transfers are now com- puted. For exa~p1e, if an Individual in the 25 percent transfer tax bracket made a net gift to. his son of $7,500, the tax would be $2,500 or 25 percent of $10,000, the amount of the net transfer plus the tax. The gift would be. con- sidered as amounting to $10 000 and the tax of $2 500 would be considered as having been paid out of it. , . ` There wöttld be a single exemption available in place of the separate estate tax exemption and gift' tax `exemption. All of the troublesome controversy concerning transfers in contemplation of death would be eliminated, since it would make DQ tax difference whether the transfer were a. lifetime gift or a death transfer. The most frequently voiced criticisffi of thIs "unification" proposal, is that It would discourage lifetime gifts Whether the proposal is seen as discourag Ing lifetime gifts or simply as not affirmatively encouraging them depends on One's starting point. The existing system contains ~significant positive encour- `agements to lifetime giving. Therefore, if .the existing system is viewed as a norm, `the proposed changes would, by compariSon, discourage lifetime gifts. On the other hand, one may more accurately state `that if the proposed changes were adopted, the new system would grant n,o ~ncourag~ment to lifetime gifts but at the same time would not discourage them either. That is, the effect of the transfer tax system on making a gift or not thaking it wOuld be neutral. While it is true that a transfer, tax becomes payable sooner if a gift is made than If the transfer Is by will upon death it is also true that if a lifetime gift Is made, the tax Is based on current values rather than on future values, and the latter can generally be `assumed to be higher. Also, in many cases, depending on the type' of gift, the future income from. the property will be taxed at the donee's lower rate brackets rather than at the donor's bracket. One important aspect of the tax influence on lifetime gifts has not been nddressed by any of the critics. The aspect referred to is the inequitable and discriminatory way iii which the present system encourages such gifts. No one 1~as yet come forward to justify a system that encourages gifts by very wealthy donors by granting them tax reductions many times greater than those granted to the less wealthy, If the making of gifts is a socially desirable act to be encouraged as a matter of federal tax policy-a premise open to substantial question-then it seems that it should b'e encouraged to the same extent for all. The only way to provide for an equitable encouragement of gifts is to adopt a unified `transfer tax system with gross-up for lifetime transfers and then allow some percentage discount in the rate applicable to gifts as compared to death transfers. The amount of the discount, would depend on how much ~encouragement to lifetime gifts was thought desirable. The argument usually advanced to support tax incentives for lifetime gifts is that it Is to the advantage of society to have property moved into younger hands, for the young will tend to be more venturesome with such capital and thus improve the economic climate by increasing the mobility and risk-taking capacity of that capital. More persuasive, however, is the counter-argument that the Government is not appropriately concerned with the rate of transfer of wealth from parents to children and should leave such matters to family decision, or at least that it is not so concerned as to provide tax incentives to affect whatever may be a family's natural inclinations in such matters. In any event, whether the consequences above asserted for lifetime gifts is true or not in a particular case at least depends to a large extent on the subject matter of the gift and on its form. Most lifetime gifts are of marketable securities placed in trust, and they are made at a time when the donor is quite elderly. A gift to a trust extending for a long period of time seems little different in terms of economi'ë mobility and risk-taking than continued ownership by the donor. The beneficial donee in this case does not have control of the prop- erty and its management is likely to be at least as conservative as it was in PAGENO="0509" 495 the * hands of the. donor, If one is in savor ~ of ett~ottragtt~g i1fetirn~ gifts, It would surely be worth analyzing just what kinds of gifts are to be encouraged Perhaps outright gifts are more to be encouraged than gifts in trUst To say that the existing system is preferable to the proposed unification be~ caUse it encourages lifetime gifts and the proposal does not, is thus to ignore both the basic problems at which the revisions are aimed and the questions which must be explored in a consideration of whether the tax system should be deliberately structured so that it Qperates in a nonneutral way to encourage lifetime gUts In this regard, ~t is d1t1k~ult to conceive of a legislature adopting a policy of encouraging lifet~1me gifts through a dir~ct subsidy approach Sup pose for example, sozueone were to propose that the !ederal government pay grants directly to those wealthy parents who make gifts to their children while the parents are alive with the largest federal grants going to the wealthiest parents Presumably the suggestion would never seriously be considered as a legislative proposal Yet that is precisely the e1~ect o~! the existing estate and gift tax system when the tax savings accorded to lifetime gifts under that systeui are translated inte direct subsidies. Gener on Sks ~i Tr s -There is an aspect of equity in estate tax a ion that is no present n the income tax and that involves a notion of perio dicity, If a given amount of wealth is, in one situation, subjected to the estate titx on three occassions over a one hundrded year period, and another accumu lation of wealth of equal amount is taxed only once every hundred years it seems obvious that the two accumulations are treated inequitably as compared to each other While cqi~iplete equity in the frequency of imposition cannot be achieved in the estate tax since its imposition depeUds on death, which is un predictable, it is nevertheless clear that notions of fairness require some approximation of time equivalence Some illustrations may belpe If an Individual with an estate of $10,000 000 ~ignoring deductions, etc,) leaves it to his two children equally the estate tax will be about $6 000 000 and his children will each get $2 000 000 Assuming that the children then live on the income from their inheritances without affecting principal each of their estates will pay an estate tax of about $750,000 ~ben the property passes to their children so that the latter will in total, inherit $2,500 000 of their grand father's wealth If on the other band, the grandfather is well advised and leaves his money in trust paying the income to his children with the remainder to his grandchildren, be will pay an estate tax of $6 000 000 the same as in the first case but the estate tax on the death of the children win be entirely avoided The grandchildren will therefore take $4,000 000 The amount passing to the grandchildren will thus be over 50 percent greater in the second case than in the first, although the effect of the two transactions over the two generations is otherwise essentially the same. This effect can. be considerably magnified by using transfers which keep property in trust for more than one generation and thereby avoId the tax on ~nore than one intervening death Skipping one or more generations for estate tax purposes does not involve shipping generations as far as enjoyment of the assets is concerned An inter mediate trust beneficiary while alive may enjoy the income control invest monte, obtain principal needed for his support be able to withdraw the greater of $5 000 or 5 percent of the principal annually during his li~et1me, and be able to give principal to others by gift or will-all without incurring estate or gift taxes except as to the amount of principal he could have withdrawn for him self at the moment of death i e $5 000 or 5 percent of the prmcipal Not only is there clear discrimination between estates of equal initial size in this sItuatIon~ but there Is also a crippling effect on progressivity This effect occurs because the generation skipping transfers described are generally avail able only to large estates Smaller estates generally cannot take advantage of this type of transfer because of the need of the interverung generations for the principal Since the tax saving possibility in generation skipping transfers is available primarily t~ large estates and is increasngly available the larger the estate becomes it results in reducing the progression of real effective rate~ Or In eliminating entirely progressivity over large segments of the estate tax Proposals have been made to eliminate this generation skipping defect of the present structure Thu~ the 1968~-1969 Treasury Department Proposals would impose a substitqte ti~x on transfers that skip one or more generations This substitute tax iS deSigned to ensure that there would be the same total tax on such a transfer as there would be if the transfer bad been made to the PAGENO="0510" 496 interve~1ing generation and then ` b~ the Intervening generation to the ultimate donee. The tax would apply whether the transfers were in trust or outright. The substitute tax would not be a penalty imposed on the generation-skipping transfer,' but rather-as the name implies-a tax to take the place of the actual tax that would otherwise be skipped. There are several methods avail- able f~r computing the substitute tax due under various circumstances. ~ If a member of the intervening generation is alive at the time of the trausfer to a donee in the subsequent generation, the ~nember may elect to treat the trans- fer as If he had received the property himself and had retransferred It to the transferee. ~or example, `If a donor (or a decedent-testator) transfers prop- erty to a grandchild and a parent of the grandchi~~-don'ee is alive at the time of that transfer, the donee's parent may elect to treat the property as received by him and retransferred by him to his child (the grandchild donee) In this case, the donor would ~ay the normai transfer tax that would be due on a gift to his grandchild's parent' and the latter, in turn, would report on his transfer tax return a gift to the grandchild-donee. If, in this situation, The donor were to reimburse his grandchild's parent for the tax resulting from the election, such reimbursement, of course would be an additional taxable transfer. Under this proposal a generation Is consIdered skipped whenever the donee Is more than one degree in family relationship below the transferor, and the substitute tax* would apply whenever one or more generatiOns were skipped. If the gift, is to a non-relative, the substitute tax would apply If the donee is morO than 25 years younger thafl the transferor. If the transfer rather than be1n~ outright, were toade In trust the inter veñing generation-~-the parents of' the donee-could, but would not be required to, make the election at the time of the transfer; the election could be made at any time prior to the death of the survivor of the transferee's parents. In the interim transfers out of the trust to the remote generation would be consid ê±ed generation-'skipplng trgnsfers. Once a parent of the transferee `makes the election, he would be, considered to be the settlor of the trust for purposes of applying the substitute tat. The amount of the gift for purposes of calculat- ing the tax due from ,the electing parent would be based on the value of `the trust' corpus at'the time of the election. The `election system would produce the same ta± result' that would obtain if the transfers were actually made to the member of the Intervening genera- tion and then retransferred by him. However, it is essential that this system be èlectivb because `the election does impose a tax liability on a member of an intervening generation `Who never in fact receives the property outright To handle the situation where no election is made, the Treasury proposal contains a, provision designed to achieve essentially the same result, but* the provision is, of course, less exact. Where no election is made, the substitute tax Is imposed on the donor at the time of the gift at a rate equal to (30 percent of the donor's marginal rate. Sixty percent of a marginal rate is approximately equal to the effective rate on the transfer. Therefore, by calculating the substitute tax at 60 percent of the marginal rate an attempt Is made to approximate what the effective rate of tax would be if the skipped generation had made the transfer, The measure, however, is necessarily inexact. This method of calculation would also be used when there Is no living parent of the donee, i.e., when no member of the skipped generation is aHve. However, in this situation, the donor may elect either to use the 60 percent method or to use the actual marginal rate `gpplicable to the estate of the last parent of the donee to die. This election" may be made by the transferor or by his executor or other representative where applicable. Where the transfer Is in trust and no election has been made to pay the substitute tax, the tax will become payable by the trustee when distributions are made to the remote generation, at a rate of 60 percent of the transferor's marginal `rate (or at the actual marginal rate of the Intervening generation's transfer tax bracket if there Is no surviving member of that generation eligible to make the election). This situation would continue until the tax is paid on the total corpus, at which point the trust would be treated as having been created by the intervening generation sQ that the subsequent distributions would not be taxable unless they are to a' generation remote from the skipped generation, for example, greatgrandchildren of the donor. There has been other, less' complete, solutions proposed to cure the genera~ tion-skipping problem. `One is to grant a special discount or deduction for out- right transfers by parents to their children. Another is to eliminate the elective PAGENO="0511" 497 aspE~ct of the Treasüj~y proposal and con~Ins the proposal to the substitute tax on the settlor-decedent, It is clear that any satisfactory solution to generatiou~k1pp1ng will involve complexities since the situation itself, certainly as respects long-term genera- tion-sk1ppi~g trust arrangements, is in~ierently coipplicated. Those arrange- Inents are complex matters, for the draftsman. must Often pro~Ject himself almost a hundred years into the future and try to perceive and handle all con- tiugenies. It is asking far too much that sucil a c~mp1ex situation be dealt with in comparatively simple fashion by the tax law. When a sophisticated aspect of estate planning is involved and that aspect Is one far removed from the o~dinary transfers of assets from one generation to the nexL, the ta~ ~pqlicy, governiz~g ~that aspect must also be sophisticated. Tax policy must per&nit *110 arra~gemeIit~ to be used for whatever non-tax phrposes they m*y~serve,. but it must not permit them to be avenues of tax escape. Less compi*. t~ax solutions may be welcame, but those Who desire to use these complicated arrangements cannot ~argue that because there Will be complexity, there must be tax immunity. The. other arguments agains~ the genpratlomskipping proposal seem 1argel~r strategic retreats. Thus, it js said that generation-skipping trusts involving two geueratton~ are rafe and there is no reason? therefore, to upset everyone for ~ few cases, T1~is argum~nt, of,~ourse can be tur~e~1 up~1de.down since onW the few,. affected would be upset. Mthers would adn~tt t~ the desirability of taxing the arrangement when two generations are skipped, but not one genera- tion, t11oug~ no explanation is wade of why ~oàae untaxed skip should be per- mUted o~ why in ~fEect the ~state tax. should apply only every other geñeratibn. Others point to~ cases in which a deoede~t's children may be dead so that the natural ~beneficiaries of his estate. are his grantlclifl'dren, or to eases In which the decedent simply does not like his children, and ask why a generation-skip- ping tax should be imposed In these cases. ~But these situations and others like them lie at the fringe of this prob1em~ 13y far most generation-skipping trans- fers occur where both chidiren and grandchildren are alive, where both are liked by the decedent, and where the children share in the enjoyment of the property during their lives. The basic tax rules must be constructed to deal with these normal situations, and the pattern of those rules sb~uld not be de- cided by the fringe cases. Nor should the fringe cases be treated in a different fashion, once the basic decision is made to impose a tax on the time patterh of every generation. Maritai Deduction.-A corollary to the proposition that estates should be taxed once a generation. 1~ the proposition that, generally speaking, they should not be taxed in total more titSu once a genethtlon. This view Is partially ac- commodated In the current estate and g~tt tax system by allowing a marital dCduction for property .,left to a spouse in an amount up to 50 percent of the adjusted gross estate snd for one~balf of an Individual's inter ~ivos gifts to a spoi,ise. Death transfers to a spouse, in order to qualify for th& marital dedue~ tion, must be outright or wust provide for a life estate With ~ general powsr of appointment, This requirement assures that the proporty lctt to the wife, for example, and deductible from the husband's estate, will be includible in the wife's estate upon her subsequent death if It has not been consumed. The estate tax marital deduction, however, is limited to one-halt of a tax. payer's adjusted gross estate. In tboss eases where the surviving spouse will not consume more property than that qualifying for the marital deduction in the decedent spouse's estate, the marital deduction with the ~O percent limit works satisfactorily, I.e., tire total amount of property subjeCt to estate tax in the two spouses' estates willS be the amount passing to the ~iext generation. in those cases where the ~surviving spouse~ will consume morn than the marital share, however, the estate of the flrst spouse to die is taxed on property that will not ultimately pass to the next generation. This is obviously a problem that arises prmarily in the case of smaller estates, Moreover, decedents leaving these smaller estates trequently.provide that more than one half of their estates shall go outright to their apouses. If les~ than this exCess ovet one half of the property is consumed by the survivor under this a~rangemeut, a portion will be subject to two taxes in passing to the next generation~ Moreover, the rules req~irjng that transfers, in order' `to qualify for the marital deduction, either be outright or provide for a general roWer of appoint- mepl~ will frequently force a decedent to lea~ve assets to his wife under an arrangement which non-tax factors may Indicate is inadvisable. PAGENO="0512" 498 The proposals in this area are all In the direction of enlarging the marital deduction, by increasing the amount of the deduction and expanding the type of transfer to a spouse that wIll qualify. Thus, under the 190S-4969 Treasury Department proposal, the existing 50'pereent ceiling on the marital deduction would be eliminated and a dednction would be allowed for the full amount transferred to a spouse up to the full value of the estate. Lifetime transfers between spouses would be free of tax. any gift by either spouse to a third per- son could be treated as made by either spouse for purposes of calculating the tax. Such gifts could be treated as made equally by each spouse, or unequally, or treated as made ent~rel.y by either one or the other. Another aspect of this proposal would be the expansion of the kinds of transfers which qualify for the marital deduction. Instead of requiring that the transfer be outright to the spouse or that the spouse have a life estate coupled with a general power of appointment as under present law, any transfer of the present ownership enjoyment use or income to a spouse would qualify for the marital deduction so long as the transferor's spouse consents to ha~ring the eventual termination of that interest treated as a taxable transfer Where the transferor s spouse has less than complete power of disposition or control of the property, the tar imposed on termination of the spouse's Interest would be collectible only out of. the property itself and would not be a personal liability of the spouse. Furthermore, an election would be given to permit any transfers which qualify for the marital deduction to be taxed at the time of the transfer. If exercised, this election would eliminate taxation upon the termination of the spouse's interest In the property. In this way, the transferor or his personal representative may regulate the amount Includible in each estate and thereby achieve whatever saving might be available by dividing the t~xation of the transfer bet*een two estates, even though all of the property Is left in a way which would othrwise qualify for the marital deduction. There seems to be relatively little objection to a proposal to increase the marital deduction. This general acceptance is not surprising since that pro- posal would benefit many taxpayers and would not directly raise anyone's taxes. The estate tax today is levied on the accumulated wealth that a person has left at his death; any savings that he conSumed during his life are not subject to the levy. A person who accumulated until middle age, for example, and there- after consuthed his savings is not subject to the estate tax on the consumption. If the husband is the first spouse to die and the consumption is by his widow, it would seem that the same principle should apply and the estate tax should be levied only upon the accumlation remaining after the combined consumption of husband and wife. However, some criticism has been made of an unlimited marital deduction as too favorable to married decedents. The main consequence of the present limit on the marital deduction, given the difference in life expectancies of men and women, falls on the family where the wife will consume all of the estate and hence the tax on the husband's half as it goes to the wife results in a tax on. property not in fact left to the next generation. The family cannot under present law~ plan out of this consequence. Hence, since this is only a problem for the smaller estates, the suggestion Is made by some that the mari- tal deduction be increased to one-half ~f the estate (as today) plus $100,000. Under this suggestion, a husband could, say with a $2~,000 basic exemption (See the later discussion), leave $250,000 to his wife free of tax (one-half of $250,000 or $125,000 plus $100,000 plus $25,000). Where there Is double taxation in the same generation today, that Is where more than one-half is left to the wife and she does not consume the excess~ the family pays too much, compared to the view that the husband-wife combination should not be taxed on more than their total wealth. But the families in this position those with the larger estates can and do plan out of this situation under the present law by splItting the husband's estate on his death and thus placing a limit on what goes to the wife. Moreover, the basic Treasury pro- posal would make this planning easier by permitting the executor to elect not to qualify property for the marital deduction. If there were an unlimited marital deduction, the families with large estates would still plan not to use the full amount permitted, since the wife would not consume the excess, and would still split the husband's estate. An unlimited marital~ deduction would here merely Influence the calculation of the split since the deferral of estate tax that the deduction would permit at the husband's death must be balanced against the payment of a larger tax on the wife's death. Under this balancing, PAGENO="0513" 499 inbre would be given to the wife than under splitting today In order to take advantage of the deferral possibilities, !n this view, there appears to be nq policy reason to add. deferral~on top of the splitting effectuated by the parties. The placing of some limit on the marital deduction does not run counter to the prineiple~,that wealth not be taxed In total more than once in a generation. Under the above suggestion of a limited marital deduction but one more gen- erous than the present deduction, some tat would be paid when' husbands with larger estates died, rather than some of their tax share, so to speak, being deferred until the wife also died. Parenthetically, the complexities of the present marital deduction lie not in the limitation to one~balf-the defect of that limitation is the Imposition of tax when the wife consumes all the estate in her lt~e-but rather~ln the. rules gov5rning the eligibility of property f~r the deduction. These complexities are removed in the basic Treasury proposal by allowing an income' Interest of the wife to qualify, Hence, the suggestion of some quantitative limit on the marital deduction does not mean any added. completity compared with an unlimited dedu~tlon, Other Matters.-There are a number of other matters which should be con- sidered in transfer tax revision. These Include a widening of the definition of. the' gross estate to cover Items' ommitted today under special preference rules, such as life Insurance paid for by the decedent but as to which he had trans. ferred the incidents of ownership and employee pension annuities payable to beneficiaries named by the decedent; the question whether a limitation should be placed on the charitable deduction; liberalization of the rules governing the time of payment of the tax due on death, especially to help family farms and closely held family businesses; proposals to go further to help these family farms by applying ~pecial valuation techniques to them that would reduce tax- able value below going to market value and then providing In effect for recap- ture of estate tax if the property is sold at a high value. Or perhaps a farm owner cotild covenant with an appropriate governmental or private unit to use the land only for farm purpose and thus reduce Its value. The covenant might also be made by the estate. The Important point here is that the problems raised regarding family farms and small businesses, which are only a very small part of the assets subject to estate tax, should not distort the rules that should apply to estates with readily liquid assets, which constitute the great bulk of taxable estates. Thus, the recent proposal of President Ford to solve the "farm problem" by giving every estate `a $150,000 exemption at a revenue cost of over $1 billion is simply wrong and out of focus. This proposal qna~titative- ly allows a very small farm tall to wag a very expensive estate taz dog. The most serious defect lii our federal tax structure today Is an incOme tax defect associated with death This defect Is the failure of the income tax to reach the appreciation In value of assets transferred at death. Our income tax system does not tax the annual appreciation in value of an asset. Yet it is clear that such appreciation is "income" and that the person benefiting from such appreciation has ~the same ability t~ pay tax on it as does the recipient of income in the form of salary or dividends. In most cases-particularly where ma~rketable securities, are Involved--the taxpayer could reach out his hand and obtain the income, i.e., sell the asset and thereby acquire the actual funds. But if he stays his hand,, our Income tax stays its. demand and the In- come-the increase in value-goes currently untaxed. In more technical terms, the income tax for a variety of reasons will await the time when the income is "realized." In some cases the person may not be readily able to sell the asset; in some cases valuation may be troublesome; other problems might arise lii the tatation of accrued but unrealized gains. The aspect here relevant is not the decision tO leave such unrealized gains currently untaxed, but rather the consequences of that decision under the present system, One might suppose that the decision not to tax the unrealized gain would result only in a postponement of the tax and not its complete forgiveness. And indeed, if and when the asset~is sold and the gain is realized, that gain will then be taxed even though it in fact may be attributable to prior years. The tax will be based on capital gains rates rather than on the higher ordinary income rate, `but that aspect of the income tax system turns on other issues. But suppose a sale .is steadily postponed and the owner dies, so that he cannot himself sell the asset. Is the postponement then to mean complete forgiveness? Our income tax structure today has just that effect-it turns postponement into forgiveness by not including the appreciation in the decedent's final in- come tax return while at the same time, allowing the heirs to take as their 68-872-76----33 PAGENO="0514" 500 hn~ome tax basis, 1.e~ their tax cost on a later sale by them, the asaet's fair market value at the time of the decedent's death. The app±eciatiOn ipso facto becomes capital and beyond the reach of the Income tax. This change from postponement to forgiveness has two far-reaching consequences. From ~a revenue standpoint, it results in a large escape from the Income tax and a' consequent serious revenue loss under that tax. As far as equitable conslderatiirns are con- cerned, it has' the effect of seriously discriminating betWeen those' families who can build their estates through such tintaxed appreciation and those who have to build the mont of after-tax dollars. The Treasury 168-1909 propocals state that In the aggregate, for 1966, the untaxed appreciation passing through the estates of those who filed estate tax returns was about $7 billion, out of total estates of `$21 billion. (An additional $4.5 billion paase~ from decedents not required to file an ~estate tax return.) For the group of individuals whose anntval economic income (including annual appreciation in asset valu~s) exceeds $100,000, the annual appreciation that is untaxed-and in the end e~aca~pes inedme tax at dea~th-'---1s about equal to all other income, both taxable and exempt, combined. For Individuals with over $1~000,000 of annual economic income (including annual appreciation' In asset values), the effective rate of income tax was about 10%. The consequence in the end of not subjecting these large accumulations of income to the income tax is clearly to provide a broad avenue of escape from that tax for the wealth- iest families-au avenue that is in addition to, and separate from, the escape that results from the use of a preferential capital gain rate for realized ap- preciation in value. From an economic standpaint, the present treatment pre- sumably produces some asset holding patterns that would not otherwise obtain, as elderly investors become locked into* the retention of appreciated assets to avoid the income tax that would result on a sale during lifetime. The complete illogic of the present system etin be illustrated in thany ways. The following example shGuld suffice: Assume that each of two individuals, A and B, obtains' throughout his adult life a salary of $40,000, all of which is used for current consumption and for the payment of income tax thereon. As- sume that each also has an Investment account used for saving. In the case of A, all of the yield is in the form of dividends and interest, averaging $50,000 a year and subject to the income tax at, say, a 50% rate. A's 40 years of after- tax accumulation in this account comeS to $1,000,000. B has his Investment account in growth securities with no current yield and with no lifetime realiza- tion of the appreciation. Assume that B's average annual appreciation is $50,- 000, the same amount as A's before-tax yield. B's accumulation over 40 years aggregates $2,000,000. By hypothesis, th~~ two individuals have comparable con- gumption patterns, i.e., they live in the same kind of house, eat the same kind of food, take similar vacations. The difference is that B's savings, and hence his estate, are built from unrealized and untaxed appreciation, while A's sav- ing and his estate are built out of after-tax income. B has been able to build up the larger estate because the income tax system stayed its hand. But once 13 has died, there is no reason for that system to continue the' postponement and leave the appreciation forever untaxed. The factors which stayed the tax initially when the appreciation accrued are clearly no longer pertinent. B's assets must now be valued for estate tax purposes and some presumably will have to be sold to pay that tax. It is certainly no answer-though some continue to assert it as if `it were- that the appreciation is not wholly untaxed inasmuch as ~ must pay an estate tax on the appreciation. The pertinent tax under consideration is the income tax which B escapes. As the Treasury proposals state: "The estate tax will fall on both A and B so it is not relevant to say that B ought not to pay any income tax on his accumulation of wealth because he pays an estate tax. A has paid income tax on the money thut he earned to build an estate and an estate tax. B avoided income tax on his wealth Increase and only an estate tax is paid on It." Suppose B had decided to sell all his securities in order either to embark on a new investment plan or to increase his consumption, but unfortunately died soon after the sale. B would then have paid his income tax on the appre- elation so that his savings are now "after-tax" as are A's savings, but B's estate will also pay an estate `tax on the savings. No one has seriously attemp-. ted to justify on any logical ground why B should go untaxed under the income tax if he had decided not to sell and had then holding the appreciated assets. There are other arguments advanced to perpetuate the present illogic and PAGENO="0515" .501 inequity, but these canr1e considered after the Trasury proposal has been described. There should be an end to this tax escape. Large sums are Involved. Thus, the capital gain preference on lifetlw,~ sales of capital assets (Inclusion of only one half of the gain) is estimated to involve about $~ billion a year. The estimate of tax lost at death (i.e.. the revenue that would be obtained If a tax were imposed on the appreciation in taxable ~estates at ordinary income rates) is place at around a $T billion figure~ (Tbe~I1gure woud be lower with the exemption under the Treasury proposaL) This makes the' total capital gain preference-~-on lifetime sales and at deo~th- around $12 billion. (The above estimate is before the effect on transfer tax. Since any Income tax Imposed at death would b~ a deductj~n from the estate tax base, there would be a decrease in estate tax payable. This is, of cobrse, also true as to any iucreas~ in life- time income taxes, and revenue estimates here are iils~-~-and properTy so-~-al- ways on a before-estate tax basis.) The 1968-1969 Treasury Department proposals recommended that the appre- ciation be taxed under the rules applicable to sales of assets. Losses would also be allowed. There would be appropriate a~erag}ug rules~ Decedents would be presumed to have a minimum basis equal to the estate tax exemption, so no income tax would be imposed on the ap~recigtion where total value was less than the exemption. Appreciation in valUe of persona1~or household effects hav- ing a value less than a stated minimum would be `excluded. Transfers to a spouse would be exempted, but would ~have a carrled~-over basis, Appreciation in value of assets transferred through generation-skipping arrangements would be reached. There would be trans1tion~d rules designed to phase hi the tax gradually. Lifetime. gifts would also subject the donor `to tax. Most of the objections to the preposal for' income taxation of the apprecia- tlon in assets transferred at death are either speclou~or are directed at debat- ing points that. are minor indeed whefl considered In the perspective of the stakes involved. Thus, some critics pereist in contending that the unrealized capital gain at death does not escape taxation since the estate tax rates apply to the full asset at death-and in co contending never bother to point out that those estates built up from "after-income tax" dollars also pay the estate tax. Others state that it is unfair to tax the appreciation~ at 4lleath since the asset may later decline in value- but convehiently overlook the fact that the estate tax itself is applied, often at much higher rates than the capital gain rate, to those same values at death, despite the possibility that tlleSr may decline. Of course, the assets may, on the other band, appreciate still more in value, but any subsequent value changes are properly' treated as gain or loss .to the heirs. Some critics make much of the contention that `the executor may not have adequate records to show the income tax basis of the appreciated assets. But most of the assets involved will be marketable securities and their basis can usually be reconstructed in the cases where it IS: not recorded. Moreover, improved record-keeping, if improvement is necessary, will come about. The situation must be kept in perspective: we are considering over $10 billion in appreciation each year, and the taxation ~x~' a significant part of this gain, if otherwise appropriate, can hardly be faulted because some records are found wanting. Some say that death i~ not a "sale" and we tax only sales of capital assets. We can hear these words but they mean nothing In themselves. All they are is a restatement of the issue. Finally, in this category is the argument that such income taxation on appreciation at death has not been imposed before in this country. This observatiofl of course is correct-and is the reason why change is now needed. It maybe observed that Canada,~i~ adopting a capital gains tax for the first time, took note of our experience and did not repeat the mistake of allowing appreciation in the value of assets passing at death to escape the income tax. There is also the objection that an income tax applied `to appreciation at death would be unconstitutional, This stainenet is ilOt the place for a lengthy legal discussion of this issue. These interested in the precedents' that can be marshalled are referred to the opinion which was submitted to Congress by the Treasury Department in 1963, in which it~'was concluded that the step would be constitutional. Suffice it to say here. that we doubt that most lawyers view- ing the legal issues objectively would wager against the tax being upheld by the courts. Others raise the argument~ that the appreciation ta the value of the trans~ ferred assets mirrors inflationary change so that taxatioh is unfair, l3ut this PAGENO="0516" 502 contention would apply as well to lifetime sales, and indeed It is one of the principal contentions pushed by opponents of any capital gains tax. Our tax ~system ba~ rejected the contention and does include capital gains in income, though at a preferred rate.~ There 1$ no reason after rejecting the contention when lifetime sales are 1rr~~olved to turn around and accept the contention when the asset is transferred at death. The aspect of inflation is a separate matter, ~relating to the treatment of capital gains in general, and cannot be turned to ~as, a defense for a zero rate of taxation on capital gains, Indeed, careful anal- ~ysis by Roger Brinner and others has shown that the longer an asset is held the less is the portion of the appreciation that reflects Inflation and the larger is the portion that reflects increase In asset value. There are more pragmatic critics who see that the sheer unfairness and illogic of the present system are beginning to be understood by both Congress and the public at large. They also recognize that, as a consequence, the time for change appears to be at hand; and hence an orderly retreat is more appro- priate than a diehard defense of the present system. They therefore agree that the present system Is wrong. However,' they urge that the corrective course is not to tax the appreciation at death, but rather to adopt a carry-over of basic system under which the decedent's basis would become the tax basis for the heirs. But this suggestion does Indeed represent no more than ground yielded in retreat, rather~ than a solution possessing any real advantages over the Treasury proposal. Moreover, the carry-over basis suggestion involves seri- ous disadvantages. To turn back to our example of individuals A and B, the former With an after~tax estate and the latter with untaxed appreciation, why should~ B's advantages persist even after his death and result in his family having a larger inheritance simply because he has thus far escaped an income tax? And why should his heirs be able to keep that larger inheritance until they sell the property? Whatever the validity of the reasons that underlie the policy decision not to tax B's accrued but unrealized appreciation during his lifetime-e.g., that he may not be able to sell the asset, that it may be hard to value the asset, that he may not have the cash to pay the tax without' a sale of the asset-those reasons no longer obtain at B's death When the im- position of an estate tax required valuation and most likely a sale of at least some of the assets in order to pay the tax. Moreover, further postponement of `the tax can only harden the lock-in effect, for under a carry-over system Ws heirs would face the' prospect that sale b~V them would result in tax liability while continued holding would not. ~Under the Treasury proposal, there is a carry-over basis to the spouse, but this Is in keeping with the unlimited marital deduction under the transfer tax for the transfer of the spouse. It is important in this connection not to lose sight of the overall situation. The problen~ is one of determining the amount of tax that should be levied on a decedent's wealth when he dies. The Treasury proposals would require a final incOme tax tally on a decedent's hitherto untaxed appreciation in asset values. This would result in a settling of accounts as between estates with much untaxed appreciation `and those with little such appreciation. Death is the appropriate occasion for these final accountings. There is' no reason to hold some of the books open and, at sOme future occasion when the heirs sell the assets, to close the books on' the appreciation. The untaxed appreciation was experienced by the decedent, and his death is the appropriate occasion for closing that account, Others have suggested that' a flat rate additional separate tax be imposed at death on the asset appreciation that exists, with this tax being in addition to the estate tax. Such an arrangement, however, lacks any basis in theory or tax principles and is not the way to proceed. It makes Impossible any rational relationship between the income tax and the estate tax. In addition, as Profes- sor David Westf all has observed, there are many technical difficulties with the arrangement. Moreover, the essential foundation for the suggestion-that a capital ga'ins tax at death is regressive-is faulty. Thus it Is argued that a system of income tax on the gain at death would be regressive because the larger the estate the lower the net amount of income tax which would have to be paid. The Federal `Government would, it Is said, in a sense by paying part of the income tax since the capital gains `tax at death would be a deduc- tion from the gross estate In computing the estate tax. Of course in that way of looking at the relationship the larger the amount of wealth in the estate the more the Government would be paying of the income tax at death. But that is true of the entire ~income tax. It is true as to all Incothe and all capital gains PAGENO="0517" 5Q~ dtring life that the income. tax on these itemsis ~n~1tted *Om th~ estate tax base because the amoui~t of hicome tax, baving b~en'. p~jd during life, is not owned, by the decedent at death. Conseg~enti~, tho st~tement that the imposl~ tion of. a capital, gains tax at death would have ~the' above ege~t is true of the entire interrelat~~nship between the ineo~e ta~nd 4~e estate, tax. The deced- ent is simply not as wealthy~ to the ex~ent óine tax ~has 1~een paid, or would be due at death, and hence his estate i~ therob~lesa t~ that extent. I~ence, any arrangement based qn the assertea "regre$~vene~s" of income taxation of appreciation at, death is based oi~, a `mislead~ng~ pre~nise. A last point urged by some critics-and resl~y the only, ~elevgnt one--is the possible effect of this proposal on e~ates,. ~ons1sting o~ ~lose1y. held businesses or farjns with significantly appreciated values. The real lsaue here is that of the liquidity, or rather the possible iuiquldity, of such estates jn that iucome taxation at death could aggragvate any di~c~lties that~nay be present In find- ing the funds to pay the taxes occasioned by death. B~it tbi~ point also must be kept in perspective. By far the majQ~ share of those estates in which asset appreciation is a significant part consist largely of ~lversified* stocks and secur~ Ities; such estates do not pvesen't this ilhiqu~dlty p~ob1em., Criticism based on illiquidity in estates where closely held businesses are involved should not, therefore, be permitted to cloak. opposit'ioi~ to th~ change over the broad area where that aspect is not present. An~ lIquh~ty di1~lc~lties that may exist in these special cases should be dealt `with directly~ just as in the ease of the estate tax itself. . , , , ` . All in all, a correction of present income tax treatment of appreciated assets at death is one of the most important issue~, 1~i tax ~eforin in the United `States~ The, proper correction is income taxation, at ~1eath of. the appreciation in asset value. , ` , ` . III. Rate and 1~keemption Lev'JZs ` `. , ,, - Most of the discussion on transfei' tax revi~ion' in' the United States has centered on the structural aspects described above. The question of rate and exe~nption levels has been relatively muted. The `1968-1969 Treasury Depart- ment proposals, in order to focus attention on the, structural Issues, ,were de- signed to hold revenues constant. The Amerieai~ Law Institute revision sug-~ gested a downward adjustment of rates. CoiIgress~onal discusslon of exemption levels has been largely confined tQ proposals to iñcrea~e the present $60,000 estate tax exemption on the simplisth~ ground that price-J,evel changes automati- cally warrant a much higher exemptlo; Thus tJ~ère Is little considetation given to the criteria that are relevant to the deteraU~ation of rate levels and exemp- tion levels. . ` , ,` Are there any guidelines that can e~s1st to sI~ap~ qu~nt1t~tive decisioñ~ on these matters? Let us start With exemptions. Thqpresent estate t exemption is $60,000, and this figure restricts the eover~ge Of the estate tax to 5 to C per- cent of adult d'ecedents. Phi's in Itself suggests that a lQwerlng' of the exemp- tion, `even a significant lowering, would still keen the `tra~isfer `.ta~t a rather exclusive levy. suppose we started the other way and .jlrst asked what exemp- tion level is required to keep mOst small `or tahior or. av~gge~ `e~tates-the pre- cise adjective is not needed-outside the scoje' of the tax. In answer to such a question, some have sttggested a f~gu~~ in the area of $25,000. We can next ask, are there persons reCeiving property fi~ôm a decedent. ,who are entitled to claim that a higher figure should be ~xsed? Thus, what about the interests of a surviving spouse, moSt likely the w1fe~! But here the marital deduction pro- vides protection for her interesst. Clearly an unlimited marital deduction with the limits suggested above-one half of the estate plus $100,000- would seem to provide the needed protection. The ~atter dethiCtion, witb'.a $25,000. exemp- tion, would permit a' tax-free. transfer of $25Q~000 to the wi~e, and less than 1 percent of widows enjoy that much wealth today, Co, given ,the marital de- duction suggestIons, the `Interests of a surviving wife do not require a higher exemption than $25,000 ., `, What about surviving children? flere ~ has been, pointed, out that in all probability the surviving children of decedOlits possesging more than $25,000 of wealth are likely themselves `to be adu1ts1a~nd çven a~u1ts well along in life~ Most decedents-four-fifths--are in the age br~X~ket of 60 year~ or over. With the head of the family at ages' 55-64; ,ohly ~0, Per$btdf married ,couplçs (1960 Census) had children under 18 years ~`4t agq 6~,;or ovOr, only 3.5 percent. While adult children may welcome inheritances, thOlf' claims are nqt usua'ly ~ounde~ PAGENO="0518" 504 ~n the need ~r hardship that can arise when the pro~4sion of support is slid- den1~ remOved, kS wo~Id be the `case for a snrvlvihg wife or minor child. We can therefOre ~hitt the h~t1lr~T to minOr children. `The Treasury proposals In- `eluded special treatment for orphan minors in the form Of a special exemption, `or dedn~tIon from the estate, of' $3,000 multiplied by the difference betweei 21 end the orphan minor's age in sears. This proposal has prompted further ex- ploration of ~special treatment for minors, and resulted in suggestions broaden- ing the approach. Thus, some hate suggested that the special exemption cover ~ninor children, whether or not' orphans, and any other persons who were ~laimed by the decedent a's a dependent for a period of years precedipg his ~ieath. In the case of elderly dependents and those not minors, the structure of the exemption would have to be related to life expectancies or perhaps use an arbitrary figure not out of line, with results for other dependents. The special exemption thus here operates ha a Cushion to counter the removal through leath of the decedent's support.' Under this overall approach the exemption can be structured in the light of the purposes an exemption should serve under a transfer tax. First, there would be a basic exemption to separate the estates that It Is desirable on administra- tive grounds to keep outside the scope of the tax, thereby permitting attention to be concentrated in the approprIate area. however, in fixing this basic ex- emption, attention has to be paid'to the pattern ot wealth distribution In the United States, so that the figure does not Screen out those whose estates, though appearing small in absolute terms when viewed from above, are large relative to the wealth, or really lack of it, possessed by those below. Second, special exeniptions woud be devised to protect those previously dependent on the de- Cedent for their support, so as to e~shion for a period the loss of that support. Minor children are an example, as are parents or relatives actually dependent on the decedent. Surviving spouses would, however, not be in this category In view of the effectiveness of the marital deduction in providing protection for the wife, When we return to the matter of rates, any legislative discussion of the proper level of transfer tax rates (and exemptions) should-but generally does not-take place against a background of the pattern of wealth distribution and of the social policy toward that pattern. In the United States 1 percent of persons is estimated to hold 219 percent of the total net worth held in 1969 by the total adult population (122 million) (the estimate for 1953 was 27.5 per- cent). 35.7 percent of total net worth is held by those having more than $60,- 000, 4.3 percent of the total adult population. This latter group owns 27 per- cent of the total real estate, 60 percent of the corporate stocks, 76.5 percent of state and local bonds, 40 percent of the business assets. (Data, from Smith, Franklin, and Witon, The DistribfltiOn of Financial Assets (19~3), the Urban Institute and Pennsylvania State University) - A look at the distribhtion of wealth in the United States would reinforce the view Qf a starting rate much higher than the very low rates of today, which begin at 3 percent an4 do not reach 25 percent for a single person until $110,000 ($50,000-$60,000 bracket ~plus $60,000 , exemption) where only about two percent of adult decedénts are found. An effective rate of 25 percent is not reached until an estate of aroupd $500,000, where less than one percent of adult decedents are pound. These factors have led some to suggest rate scales starting at 20 percent after a basic exenjption of $25,000 (and keeping in mind the marital deduction and special exemption for dependents), rising to 30 per- cent at $50,000, to 50 percent at about $500,000 and up to 80 percent at $5,000,- 000. It is easy to lose perspective in considering the estate and gift taxes. In one aspect they resemble the income .tax, for they have a basic exemption and then a progressive rate scale. As a cCnsequence, one is apt, to approach the estate and gift taxes with individual incOme tax attitudes, such as be careful about making exemptIons too low, be careful about the height of the starting rates, be careful about the pace of progression. But such Income tax attitudes derive from the fact that the present income tax has a wide coverage of the population in the United States. About 80 percent of the population of 21 years or over file income tax returns and nearly all of these-or 75 percent of the same popu- lation-pay an income tax, These income `tax attitudes have real meaning and force under such circumstadces. indeed our income tax starts today at poverty levels, and unless care is taken, `as it wds in 1971 and 1975, to see that the combination Of the low incOme alloWance (minimum standard deduction) and PAGENO="0519" ~O5 personal e~~ptio~is, (plus a spe~i~ai credit ii~i i97~) is raIsed i~ei~iOdtca11y, the 8tartu~g pc~1nt coul4 fail below those peverty levels as the price level izicreases Ei~t the starting point o~ "wealth the distribution of wealth~ and eonae quently the universe o~xiupied J~y the estate and gift taxes are all far different lii such a `univeroe, in~ome tax attitudes can easily jegtl one astray. Thus, the present estate tax is imposed on the estates of decedent~ with net assets of over ~60,000. Yet only- about ~ o~' Q percent of adult decedeuts leave estates of that size; only about .2 of 1 percent of adult decedents leave taxable estates of over $5O0~00Q. 5rytl~li~g t~at thus takes place In the estate tax concerns less than 5 or 6 percent of adult decedents, while eyerythfng that takes place iti our individual incoitue tax eonce~ps 80 percent of the adult population The concentration of wealth In the United States Is clear~y more marked than the conce*jiation of Income. There is a vast difference between speaking of the "little man" under the individual income tax and the "small estate" under the estate tax. Yet pro- ponents of a low estate tax c~~r~y pver to the "small estate" the protectionist attitudes involved In the reference to the "little man." The "small estate," it is true, is less than a dwarf in the scai~ of large estates, but viewed from the perspective of almost all of our population the "small estate" represents wealth beyOn~ the vealith~s of most everyone. UnIes~ that perspective Is kept con- stantly in mind the estate tax will never be an effective tax on the transfer of wealth In the United States. IV. Conclusion The large study of inherited wealth irs our society under modern conditions has yet to b~i made-the amount of the wealth the patterns under which it is created and trax!~inltted-from whom to whom, Its uses its consequences the institutions It affects; and so on. Such a study mu~t focus on the factors which permit large fortunes to be created and passed oil from one ~en~ratlon to another despite nominally high income and transfer tax rates. This focus would undoubtedly throw light on the contrast between, on the one hand, struc- tural weakneses and preferential provisions in these taxes and, on the other, tho~e nominal high rate structures. The study will have to be done. In the meantime enough is known to demonstrate that the present estate and gift taxes in the United States along with the income tax escape of the appreciation in assets transferred at death, are not only weak instruments to reach the transmissiOn of wealth, but are also e~tremeiy uneven aud Inequitable in their lalpact among the families that possess wealth These taxes and the related incOme tax escape at death are thus prime candidates for long-needed revision. STATEMENT OF DAVID WESTFALL,1 PROFESSOR OF LAW, HARVARD LAW ScHooL, CAMuRIDGE, MASS., ON BEHALF OF TAxATION WITH REPRESENTATION SUMMARY OF SEATEMENT Estate and gift taxes aye an. ideal source of federal revenue which Is largely unused. Oongressional neglect for 35 years has left the rates too low, the exemptions toQ high for taxpayers without dependents, and a large number of loopholes which permit the taxes to be minimized or avoided alfogether by clever planning. The $60,000 exemption is too low for the young father who leaves a wife and minor children and too . high for the bachelor without dependents. It should be reduced to $20,000 and changed to a credit, with more liberal provisions for spouses under the marital deduction and for depOndents. Rates should start at 20% tO bring the tax on gifts and bequests in line with the Income and social se~urlty taxes paid by workers. Both taxes should be combined in a single transfer tax. 1 David Weetfall is a Professor of Law at the Harvard Law School, where be teaches Estate Planning and Property Re received his A B degree from the University of Mis sourS ip 19,74. ~i~s I1L~B. de4ree from Rarvayd In 19~O. Professor Weitfall has published Est-~te Planning Pyoblems (Ponndatlon Press 197'i) ~snd Readings in Taxation (with Professor Sander Foundation Press 1970) He was formerly. en associate at~BSli, Royd, ~arshall & Lloyd, Ch1ca~o 19~O-55. He was Assis- tant Reporter for the American Law Institute's ~state and Gift Tax Project, 1961-66, and served as Consultant to the Treasury, 1964-65. PAGENO="0520" * The charit~thle deductiOn shOuld be lithlted to one-half of the estate. A parental deduction should be provided to off~et the advantage from gen- eration-skipping trusts, which sometimes allow inherited wealth to be enjoyed by children, grandthildren and great-grandchildren without any of them pay- ing an estate or gift tax, and additional takes should be imposed on trusts which skip two or mor~ generations. Present loopholes in the taxation of life insuraned and employee death bene- fits should be closed. The present interest exclusion should be reduced and tightened and the state death tax credit should be: repealed. * No special treatment of farms is justified, aside from liberalizing the pro- visions for deferred payment of the tax. Unrealized gains when assets are transferred by gift or at death Should be subject to income tax. MODERNIZING ESTATEANfi GIFT TAX jntroth~ction Estate and gift taxes are an ideal source Of federal `revenues which Is largely `upused, Before World War II they produced 7% of the total but todav their share is less than 2%-under $5 billion in fiscal 1975. Yet a well-drafted estate and gift tax law could combine two of the best features any tax can have: (1) reliance on ability to pay; and (2) minimal interference with taxpayers' incen- tives to. work and invest. Our present laws fall far short of this ideal because Congress has neglected estate and gift taxes for. 35 years, while the income tax aitd, social security tax have been refined and perfected into efficient means of collecting large amounts from masses of individual taxpayers, This neglect has left the estate and gift tax rates too low, the exemptions tQo high for taxpayers without dependents, and a large number of loopholes which permit the taxes to be minimi~ed or avoided altogether by clever planning. We like to thlnk that our present system is based on ability, to pay. Yet the $570 million estate of Ailsa Mellon Bruce, who died in 1069,~ paid less than 1% in federal estate taxes because the bulk of the property weüt to the Mellon Foundation. The tax would have been no mOre if she had chosen Instead to leave her husband as much as $285 million. Another example is provided by the late Irenee duPont. About two months before he died in j963, his guardians got court approval to make gifts of $36 million out of his estate of $176 mi1~ lion. By making the gifts just two months before he died, the guardians ap- parently saved over $16 million for duPont's beneficiaries. On a more modest scale, an individual who inherits a million dollar estate, no matter how large his Income, pays only $270,300 in federal estate tax. At the other end of the scale, the average working man or woman pays a 5.85% combined social security and hospital insurance tax on every dollar earned and an income tax which starts at 14%. If the estate and gift taxes are to work fairly and effectively to produce substantially larger amounts of revenue, major changes are needed In their structure as well as in the exemption and rate schedules. Any special problems of farmers should be dealt with separately, rather than by distorting the basic provisions of the taxes. I. Ewemption and Rates . Arguments for raising the exemption usually are based `on inflation, reduc- ing the tax burden on small estates, and sparing executors inconvenience of filing returns for small estates. None of these stand up. Inflation would be a reason to raise the $60,000 exemption if it made sense when that figure was first introduced in 1942. But a $60,000 exemption, without regard to whether the estate goes to the decedent's widow or minor children or his wealthy third cousin, didn't make sense in 1942 and doesn't make any better sense today. The income tax tailors the taxpayer's bill to his ability to pay by taking into account how many others ate dependent on him, and the estate tax should do likewise, For the young father Who leaves a wife with three or four minor children to raise, $60,000 is far too little. For the bachelor who leaves no one who depends on him for support, $60,000 is far too much today, even with inflation. The marital deduction, as liberalized In the bill, PAGENO="0521" 507 takes care of the decedent's spouse, and the Treasury's 1969 proposals included an exemption wl~ich would have taken care of orphan children as well, to the extent of $8,000 for each year remaining until the child reached 21. If this were broadened to cover other dependents, it would be appropriate to cut the exemption to $20,000 and change it to a credit equal to the bottom bracket rate on that amount. The present exemption has far greater value in Mrs. Bruce's estate, where it reduces the tax by 77% of $60,000 than it does for someone who is at the bottom of the scale. A $150,000 estate may be small in comparison to the $570 million left by Mrs Bruce But from the standpoint of the rest of the population It is quite large. According to the latest figures, only about 9% of the population manage' to leave as much as the $60,000 it takes `to require filing a return, and about a third of the returils show no tax due because of deductions and the exemp- tion. This means that the estate tax is limited to about 6% of the population.' So there Is no reason to keep the present exemption to relieve small estates. `Finally, the Inconvenience of filing* returns for small estates can be reduced by simplifying the return itself, just as was dOhe with the Income tax when it' began to apply to larger numbers of people. Rates have not been lnc~ëased for 35 years and begin at only 8% for' the estate tax and 214% for the gift tax. The income tax rate for the average' working man or woman Is almost five times as high. Combined' with 5.85% social security and hospital Insurance `tax, the rate on earned income dwarfs the lowest rate on gifts. One commentator has suggested that the estate tax should start at' 25%, with broader brackets. See Blttker, Federal Estate Tax Reform: Exemptions and Rates, 57 American Bar Association Journal 236, 240 (1971). `As a minimum, the initial rate should go up to 20% to put It on a par with the working man or woman's `income and social' security taxes. II. Unification of Estate and Gift Tàwes in a Single Transfer Taa~ The Treasury's 1969 proposals set forth completely and persuasively the case for combining estate and gift taxes ` in a single transfer tax, and there is no need to repeat here what was said there. Of the various arguments which have been made' In favor of' the present dual system, only one merits serious discussIon. It is often said that the reduced rates and separate rate schedule for the, gift tax as well as the fact that the tax applies only to net gifts, ex- clusive of gift tax, provide an Incentive for lifetime gifts and encourage the movement of wealth from tbe~ older generation into younger bands. Why such~ an~ incentive is desirable is u~nally not spelled out. `Moreo~0r, the effectiveness of the present tax advantages in providing an incentives for `the movement of wealth into younger bands is blunted by `the fact that~ such advantages' are equally available for gifts In trust, in which control may remain with a trustee who is no younger than the transferor himself. 1'II. The Marital Jieduction and Gi~tt-Spfltting There ~s substantial justification for liberalizing the present percentage urn-, itation and terminable interest rule. A. The Precentago Limitation.-An unlimited marital deduction would be unsound. It would benefit the childlesS widow who receives a $20 million' ~state, freeing her from the $6 million tax she now `pays. It would cost an estimated' 13% of present estate and gift tax revenues. Although part of the' loss is merely postponed until the surviving spouse" dies, ~r her interest term- inates., part is `lOst forever If she spends the `principal or makes `gifts under the~ annual exclusion. And the part that is postponed will not be cOllected, on the' average; for' more than 10 years. For some widows, however, the increased estate tax rates and reduced exemption that are'proposed here would be a hardship without some liberaliz- ing of the percentage limitation. For example, the limit could be 100% of the first `$100,000 ;ln the adjusted gross estate and 50% of the excess. This would mean that if the estate were $300,000 the widow could receive tax-free $200,000 plus the' amount of the specific' exemption. B. The Terminable Interest Rule.~-Aity income interest bequeathed to a wife should qualify for the inarWai' deduCtion `if she agreed to treat the termination of her interest as a taxable transfer by her. There have been. many contro-, versies between t~xpay'ers and the Service over whether the wife had the PAGENO="0522" 508 kind of power of appointment required under the present rule. And in some instances the wife received the kind of power which would cause the property to be taxed on her death but which nevertheless failed to qualify for the marital deduction on her `husband's death, thus creating a trap for the unwary draftsman. IV. The Charitable Deduction One of the most surprising features of the present estate tax is the un- limited charitable deduction. In practical terms, as noted above, this means that Ailsa Mellon Bruce could leave an estate of $570 million `and' avoid paying as much as 1% in federal estate taxes by giving her wealth to the Mellon Foundation. In 1966, five large estates made a total of $200 million in charit- able bequests and paid less than $8 million in federal estate tax. This diversion of potential estate tax revenues would become even more serious if the rate increases proposed above were enacted. There is no way to determine how much the unlimited charitable deduction actually influences the level of charitable giving. `It seems probable, however, that many decedents make charitable beqeusts not for tax reasons but rather because they are interqsted in a given charitable organization and believe that any other beneficiaries are adequately provided for. The `Treasury concluded in 1969 with respect to the income tax charitable deduction that "noneconomic motivations have considerable influence on the level of giving." Treasury Dep't, Tax Reform Studies and Proposals, at 198.) If a simiLar conclusion applies to deathtime transfers to charity, much of the tax revenue lost through the charitable deduction may be wasted as far as inducing gifts to charity that wouldn't be made anyway. The extensive changes made by the Tax Reform~Act of 1969 `in the income tax treatment of charitable organizations and their contributors provide guide- lines for restricting the estate `and gift tan charitable deductiOns as well. A first step in this direction would be to restrict or deny the deduction for trans- fers to private charitable foundations. Secondly, some overall limitation should be placed on the charitable deduction to insure that the doror or decedent makes a contribution to public purposes financed by the government as well as to charitable purposes of his individual choosing. For deathtime transfers, an appropriate limitation would be 50% of the adjusted gross estate, reduced by the marital deduction. This would mean that if the adjusted. gross estate were $1 million and the marital deduction gifts amounted to $400 thousand, the maximum deduction for charitable transfers would be $300 thousand (50% of the remaining $600 thousand after the marital gifts were deducted). Reducing the adj'usted gross estate by the marital deduction gifts is necessary in order to' keep the combined: charitable deductions on the deaths of husband and wife from exceeding 50% of the husband's adjusted gross estate. It is more difficult to determine what restrictions should be placed on the present unlimited charitable deduction ~for gift tax purposes. In view of the Congressional policy to encourage such gifts reflected in the income tax charit- able deduction, it does not seem appropi4ate that gifts which are deductible for income tax purposes should be subject to a gift tax. V. G neration-~kipping Trana era ci tioa Present law *scr.mlnates against outright gifts and in favor of trusts and other arrangements under which' property will nOt be taxed again when the beneficiary dies. If `a father gives his son $1 million outright, the money will be taxed again when' the son dies unless he spends It during his lifetime. But if the father gives his son $1 million in trust, the son can have almost the same control over the money without having~ it taxed when he dies. He can be given income' for life; the right to withdraw each year tha greater of 5% or $5,000 from principal,' in addition to principal required f~r his support; and the right to make gifts of principal required for his support; and the right to make gifts of principal during his life or by his will. Nothing will be taxed When he dies except for the principal he could have withdrawn at that time, in addition to his right to support-a maximum of 5% of the value of the trust. Even `that amount need not be included in his estate If the power to withdrawS principal is only exercisable if the son Is living on the last day of the year and he dies earlier. After~ the son's death, the father's will may provide that the same arrange- ment will continue for his grandchild for life. Depending on the local version PAGENO="0523" 500 of the Rule against Perpetuitles and the duration of the lives selected to avoid a violation of the Rule, the same arrangement may be continued, still free of estate tax, for later generations oil descendents. Indeed, in Wisconsin there is no restriction on t1u~ duration of trusts if the trustee has the power to sell, and the common law Rule AgainstPerpetuities is not in force~ The potential saving in estate taxes from a perpetual trust in that state "to pay the income to my issue from time to time living" is impressive indeed. This state of affairs should not be allowed to contiflue. Today it offers irn~ pressive advantages for taxpaye~rs willing and able to create trusts (or com- parable legal interests) under which bnetlciaries do not become owners of the trust property so as to rause it to be taxed in their estates when they die. Those advantages would be even more compelling ~if the rate Increase and~ reduced exemptions that are proposed here became law. Congress has already acted once, in 1942, when it enacted the predecessor to Code ~ 2041(a) (3) and~ ~ 2514(d), the gift tax counterpart, to deal with a possibility under Delaware law for perpetual tax-free family trusts. It is time that it acted again to close this avenue of avoidance. The problem is often referred to as "generation-skipping" because tax avoid- ance occurs when property passes to a later generation (in the example just given, that of the grandson) without being subject to transfer tax on the death of a member of an earlier generation (that of the son). For transfer tax pur- poses, the son's generation has been skipped. Such skipping may occur whether or not the son actually receives any beneficial interest in the property. For example, the intervening generation has beeli skipped even though no member of that generation receives any beneficial interst. An easily understood and administered way to deal with the skipping of a single generation is a "parental 4eduction," slmlla~ to the gift tax marital deduction in present law. The deduction Would provide a reduced transfer tax rate for transfers to children of the trailsferor which do not involve generation- skipping, either because the child receives ownership of the property or be~ cause he receives a general power of appointments over it which will cause it to be taxed when he dies, if he doesn't dispose of It during life. The major purpose of the pavental deduction would be to offset the tax advantage from skipping the children's generation. It would seek. to make the total transfer tax cost roughly the same, whether property was left In trust for a child for life with remainder to the grt~ndchildren of the transferor or was given outright to the child and then in turn given by him to the grand- children. With a parental deduction, a father who wanted to give property to his son would no lØnger be under the heavy pressure from present law to limit the son's righth In the property in order to keep it from being taxed when the son died. A 40% deduction would `be needed to give the transferor the same benefit which he could obtain from a transfer which skipped the son's generation. Over a wide range of rates, `a ta~ on 60% of the transfer from father ~to son plus a tax on 60% of the transfer from son to grandson would be approximately equal to a single tax on the entire property which would have been payable if the father had given It directli to the grandson or bad given It in trust for the son for life with the remainder to the grandson. Admittedly, a parental deduction would reduce the effective tax rate on transfers to children. Such a reduction, in comparison to rates paid on transfers to collateral relatives, has long been the rule in state inheritance taxes. Any resulting revenue loss should be made up by increusing estate tax rates. A parental deduction has the merit of offering a positive Inducement to trans~ ferors to forego generatlon~skipping, rather than imposing a penalty. It would offer a practical alternative for transferors who wished to avoid the complex- ities Involved i~ the creation of long-term trusts, If a parental deduction established a difference in tax between arrangements which skipped no generation and those which sklppe4 the single generation of the transferor's children, an additional tax Could be imposed on arrange- ments for skipping of two or more generations of the transferor's descendeiits. VI. The Present Interest Ea~cZv$ion The present Interest exclusion of $8,000 (originally $5,000) was Included when the current gift tax was enacted in 1932 to elirainate the need to report small gifts and most wedding and Christmas gifts., Today, many donors base substantial annual gift programs on the exclusio~i, using It to transfer signifi~ PAGENO="0524" 510 cant amounts of wealth~ to their descendents tax free. With gift splitting, the exclusion is $6,000 for a married donor. If he has 10 grandchildren, during a ~5-year period be c~an transfer $300,000 to them free of tax. To curb such transfer tax avoidance, tl~e exemption should be ~reduced to $1,500. The exemption is abused today by transfers In trust. An Interest in trust income has been held to qualify for the exemption, even though the trust con- sisted of non-dividend paying stock In a corporation controlled by the donor and his brother. See* Rosen v. Commissioner, 397 F.2d 245 (4th Cir. 1968), which, however, the Commissioner has stated will not be followed. See Rev. Rul. 69-344. Gifts of income interests are traditional estate planning devices, not typical Christmas presents. The exclusion should be denied for transfers of limited interests (including interests In trust) unless the transferee re- ceives the equivalent of ownership, as in the case of the present interest trust for minors under § 2503(c). VII. Life Insurance and Employee Death Benefits Section 2039(c) provides an absolute exemption for employee death benefits which are not payab'e to the executors and administrators of the deceased employee. No other asset is given comparable treatment, and there is no justifi- cation for excluding such death benefits from the gross estate. The exemption, accordingly, should be repealed. Although life ir~surance is not treated as liberally as employee death benefits, in that it is includible under section 3Q4~ if it either is payable to the insured's executors and administrators or the insured possessed Incidents of ownership over the policy, in practice It is not difficult to keep insurance out of the in- sured's estate. The common method of achieving this result is for the policy to be taken out by the insured's wife or child, who then pays the premiums, often from funds provided by the insured himself. Until the enactment of the Internal Revenue Code of 1954, the premium payment test caused policies to be included in the insured's estate to the extent he had paid th~ premiums, even though he possessed no incidents of ownership when he died. Removal of the premium payment test has led to the avoidance of large amounts of e$tate tax on policies financed by the insured. Restoration of the premium payment test would be one way to curb the avoidance of estate tax by means of policies taken out by the insured's spouse or child but paid for by the insured. The premium payment test does, however, create a proble~n of tracing. of funds to determine to what extent they are attributable to the decedent. An alternative approach would be to require in- clusion in the insured's estate of policies with respect to which his spouse or a trust for her benefit bad the incidents of ownership, without regard to the source of funds used to pay premiums. This would be analogous to the treat- meat of insurance trusts for income tax purposes under section 677, under winch it is no longer material thatincome is used to pay premiums on policies on the life of the grantor's spouse, rather than the grantor himself. Such in- elaislon of policies owned by the spouse of the insured would eliminate the pirdblem or tracing funds between spouses. At the same time, hardship could be srvcdiind by the liberalized marital deduction limit proposed above. In the case of policies ~eld by c~iildren of the insured, or trusts for their benefit, tracing problems are likely to be less difficult than between spouses because parents and children are Less likely to treat their combined assets as a single fund than are husbands ~nd wives. Accordingly, with respect to policies held by chijdren or trusls for their benefit, restoration of the premium pay- ment test is the more appropriate ~oltitjon. VIIL state Death Taa~ Credit Roughly one-tenth of current federal estate tax revenues is lost to state treasuries through the credit for stdfe death ta~e~. The credit should be re- pealed for ~everal reasons. Repeal would raise federal revenues, simplify death taxation, and would be consistent with unification of estate and gift ta±e~, as discussed ábov~. Althoi~gh repeal would result In a decrease in state death tax reventies, the reduction is unlikely to be substantial. In recept years, the credit has accounted for less than half of total state death tax collections. Relatively few states impose a tax which is limited to the amount needed to absorb the credit-only 4 as of January i, 1q69. When the credit was first introduced in the 1920's, it was thought necessary in order to keep interstate competition for wealthy residents from leading to PAGENO="0525" 511 the repeal of state death taxes, Such competition no longer prevents the Im-. position in most states of. taxes which exceed the federal credit In many estates. Finally, the state death tax credit is an a1uaclirQnist~c, primitive form of revenue sharing. It Is unfair for a state which attracts. retired persons in large~ numbers to collect a portion of what would otherwise be federal estate taxes. from their estates. General ~evern~e sharing now pyovtdes a more efficient and~ rational means for the allocation of federal tax revemies to state governments.. IX. Farms It is often suggested that special prob1em~ ot fa~nler~ under the estate tar require an increase in the exemption or a mo2lficat1cii~ of the rules for valuation of farms. I do not believe any such special relle~ ~ ne~ded, apart from some liberalization of present provisions for deferred payment of the tax. If the Committee concludes that further jrelief is' needed, 1t~ ~bould be provided sep- rately rather than by changing the basic provisions ~pplieabl.e to all estates, such as the exemption. The Burleson Bill (H.R, 1793) Illustrates one approach in reducing estate tax burdens for farmers, by allowing the executo~r to elect to have "qualified real property" valued at the use in which It qualifies, rather than, at fair market value in its most valuable use. A great many reasons have been given for such relief. It has been `said that the present law forces farms to be ~~ld to pay the estate tax, with the result that ownership passes out of local hands into large corporations or developers and may be changed from farming to other uses. It is also said that present market values for farm laud are illusory and re- flect inflation, rather than real values. ~None of these reasons provide suf~ ficient support for ignoring the real value of t~ie land in computing the taxable estate. At most they justify some liberalization hi pr~ylslons. for deferring pay- ment of the tax. Some farms doubtless are. sold i~a, order to pay the estate tax, but such sales create opportunities for others to enter farming ttnd make available potential building lots .near cities. Our need for more housing will not be relieved by, encouraging farmers not to sell their farms for home sites.. As to "illusory" market values for farms, the present valuatiOn rubi operates to limit the value for estate tax purposes to what" a willing buyer would pay. This Is the rule for all other assets and it is unfair to make a special exception for farms. I. Untaaed Appreciation'at Death Although the problem of untaxed apprecIation at death'bas great importance, it relates to the income tax, ,rather than to the estate tax, It therefore is dis- cussed separately in an Appendix. Appendix UNmxm APPUECIATI0N AT DE~&Ti~ Some authorities have described the failure to `tax unreallzed~ appreciation of assest transferred at death' as the most sex~1ous def~et in the Income tax.. As of 1966, the Treasury estimated the amount of gain Which thns escapes the income tax at $11.5 billion per year, It Is dift1cu1t'~ to find any justification. for con~ tinuance of a loophole of `this iuagnltttde, Some, iei~rtheless~ have done so.. One objection made to taxing gains is `that su~h gains merely represent the effect of inflation on asset prices. Certainly Inflation should be taken Into ac- count generally in computing the amount of re~tlIzed gain wheni assets are sold or disposed of. The present systeta, under which the taxable gain on an asset bought for $10,000 and sold In 197fi for $25,000 Is the same whether the pur- chase occurred in 1932 or in 1972, is grossly unfair to sellers who have held assets for extended periods during which th'e purchasing pewer of money has declined substantially. But the appropriitte solution to this' problem is a gen- eral provision to rt~compute gain on all taxable~dispositious of assets,. See. `Price-Level Basis Adju~tment--A Modest Prop~saI," 2~ Thx Lawyer 18~ (1973). To grant relief only' to those who~liold asset~ until death by imposing no tax on asset appreciation is wholly arb1t~ary. In a gfrerr case, the appreci- ation m~ be far greater than the rate Of iafl~tiOn durfhg the period the' asset was held. ` ` PAGENO="0526" 512 The major ldternatives that hate been proposed to deal with gains at death are (1) the Treasury's propd~tl in 1969, under which suCh gains would be includible in the decedent's final income tax return; (2) the American Bankers Association proposal for an additional estát~ tax (AEiT) on net appreciation of estate assets, described in Corey, Possible Changes in the Basis Rule for Property Transferred by Gift or at Death, 50 Ta~es 831 (December, 1972) and (3) extension of the present carry-over basis rule for gifts to transfers at death as well. The Treasury proposal represents the soundest approach of the three, although it could be improved by some revisions in technical aspects. A. TilE TREASURY'S 1969 P~OPO5AL; INCLUSION or ~JNRRALIZED GAThTS IN TIlE DE- CEDENT'S FINAL RETURN AND REC0qNITI0N OF GAINS ON LIFETIME TRANSFERS BY VIFT What the Treasury pr~posed in 1969 was that "persons holding appreciated capital assets at death would be treated as if they had sold such assets just * before death, and such gains would be taxed In the final Income tax return of the decedeilt." The income tax on such appreciation would be deductible in determining the amount of property subject to estate tax. The assets taxed at death would then have a basis equal to the value at death, just as is true today. items of income in respect of a decedent also would be included in the decedent's final return, eliminating the present complexities of section 691. Similar treatment would be applied to lifetime transfers by gift, which would also receive a new basis to the fair market ~ralue at the date of the gift. To fail to do so would be to create an artificial thcentive for lifetime gifts. It might also lead to a long-terth deferral~ of tax as property thight pass from one donee ~to another by gift, always with Carry-over basis and no recognition of un~ ~realized appreciation. it is only fair that au individual Whb has enjoyed the benefit during his lifetime of deferring recogn1tio~ of gains for tax purposes should be required to accouflt for such gains in his fin~t1 rett~rn when he dies. Any other provision continuesk the lock-in effect of presOnt law, under which taxpayers are kept from selling appreciated ass~l~s by the knowledge that assets retained until death obtain a new basis ahd the appreciation of such assets Is never taxed to anyone. 1. UIticisnis of Treasury Proposal It is appropriate to turn now to some of the criticisms which have been made. of the Treasury proposal. First, some have objected that the provision for a . deduction, for estate taX purpOses for the Income tax on appreciation at death makes the latter tax iegressive. They point out that for an estate in a marginal bracket of 77%, each dollar of incothe tax on appreciation at death costs the estate only 23 cents because of the offsetting reduction in the estate tax. On the other hand, for an estate iii a marginal bracket of 25%, each dollar of income tax on appreciation at death costs the estate 75 cents. These obser- vations are, of course, factually correct-but equally true of any income tax or other tax paid by the decedent during, his life which likewise reduces his taxable estate when he dies. In that sense, every tax is regressive because it reduces the taxpayer's taxable estate, and that reduction means more the higher the marginal estate tax rate is. Moreover, the capital gains tax is itself progressive at one-half the range of rates for taxes on ordinray income. The bottom capital gains tax is 7% (half of the first bracket on ordinary income) and the top rate on capital gains is 35% (Ignoring the minimum tax). Thus the capital gains tax is highly progressive-the top rate is five times the bottom rate. This difference in rates may more than offset the greater value in a larger estate of deductions which reduce the taxable estate. So the objection that the income tax on appreciation at death is regressive is without ~ubstantial foundation. Others have objected that the ta~ rate applied to lifetime of unrealized gains should not be determined by the happenstance factors that may affect the decedent's tax bracket for the year in which be dies. Thus the other in- come reportable on the decedent's final return will be affected by whether be dies at the beginning or end of his taxable year, whether the final return is a joint return with a surviving spouse, and whether death occurs while he has substantial earned Income from current employment (or deferred compensa- tion) or not until after retirement and at a time when deferred compensation PAGENO="0527" 513 Is no longer being received. It is true, of course, that these factors ma37 affect substantially the applicable tax bracket on the decedent's final return, and thus the tax on applicable appreciation. But the availability of liberalized in- come averaging substantially limits the importance of such efforts. Further libe~iization, for example, by treating averageable income as if it had been received over 10 years instead of the five years provided in present law (using, however, only the four years preceding the year of death as the bases for computation) should greatly reduce the force of the objection that th tax on a lifetime of unrealized gains is being determined by bunching such gains in income for a single year. Inclusion of items of income in respect of a decedent has been objected to on the ground that such Items are "not marketable and/or difficult to value." (Covey, p. 841) The valuation objection is without substance, as such Items must in any case be valued for estate tax purposes. Whether it is a reasonable conclusion that items of Income in respect of a decedent are any more difficult to value, on the average, than other estate assets is questionable. The classic examples of such items-unpaid salary, accrued Interest and dividends-pre- sent no significant valuation problems. Finally, there is the familiar objection of complexity which assails almost every proposal which seeks to make our tax system work more fairly. In this case, however, the objection is, as usually is not the case, accompanied by a concrete alternative which Is said to achieve the desired reform without suf- fering from similar complexity. Before turning to the alternative proposal for an Additional Estate Tax (AET), it is appropriate to consider the technical aspects of the Treasury proposal. 2. Techn~cai Aspects of T~easur~j Propd~a1 The Treasury would have exempted from taxation of unrealized gains at ~leatb, transfers to spouses, to charities, and to orphan children (to the extent such transfers were exempt from transfer tax as well). Except for charities, such an exemption is entirely appropriate and would carry out a policy of per- mitti~g tax-free provision to be made for spouses and dependents of the de- cedent. At the same ti~ne, ultimate loss of revenue would be avoided by means of a carry-o~er basis wbiàh wpuld cause the unrealized appreciation to be taxed when the, property was sold or disposed of by the spouse or orphan child. Such an exemption is inappropriate in the case of transfers to charities, bow- ever, as' no tax woi~ild. be impo~e~l on a subsequent disposition by the recipient. ~The unrealized appFeciation at the decedent's death would thus escape tax- ation al~oget~er. Taxing such appreciation would be in keeping with the pro- posal ~n. this paper to restrict the estate tax charitable deduction. A s1rQ.nger argument can be made fç~r retention of the present treatment of lifetime transfe~s Øf, appreciated property to gliarity, even though recognition of gain slipuld be )~eqnired on such transfers at death. The tax treatment of such transfers was extensively considered by Congress in connection with the ~Uax fleform Act ~f i9~9 apd reflects an evident purpose to retain some in- centives for lifetime charita~ble gifts of appreciated property. The `l~'res~sury took the view that, in order to prevent the availability of exemptions from leading to ~rtificially-jnduced bequests of, low-basis assets to spouses, or~hdns, an4 charities, it was necessary to reallocate basis between exempt and non-exempt property. This highly complex aspects of the proposal would mean , that if half the decedent's assets passed to his spouse and half to his adult son,~pr4y one-half of, the total appreciation would be taxed without regard to whlch transferee received the particular assets which bad appreci- ated. The spQuse would receive whatever basis were needed to Insure that the remaining.gaiu would be~ taxed to her when she disposed of the property (if the value ~f the property were unchanged at that time). Such an allocation Is `wholly uni~ecessary and artificial. It is true, of . course, that income tax considerations doubtless would affect `the ~boi~e of assets to be be4ueatbed, to a spouse and would create an Induce- ment for the transfer of appreciated assets to a spouse.. As a theoretical ideal, the Income ta~x, should `be neutral with respect to the choice of assets to be ~transferred to a particular transferee. But as long as we have. progressive rates, that ideal cannot be attained because the Income tax bracket of the transferee inevitably may influence the transferor's choice of high-yielding or low-yielding assets to transfer. Admittedly, the opportunity to postpone PAGENO="0528" 514 taxation of unrealized gains, if such gains represent: a major fraction of the value of the property, may create a greater distorting influence .in the choice of; assets to be transferred than the income tax bracket of the transferee does today. But the price of avoiding such distortion is very high. The reallocation of basis between the assets transferred to the surviving spouse (and orphan children) and assets transferred to others would greatly complicate the income tax situation of all transferees, because none would know the basis of the assets which they received until the final determination of values for all assets included in the estate. A change in the value of one transferred asset would require a recomputation of basis for all of the others as well. Furthermore, the rule would be confusing for many transferees who could be expected to understand a rule under which the basis for the assets received is either the date of death value or the decedent's cost, but not a re- allocated hybrid. Some commentators appear to assume that the proposed exemption for trans- fers to spouses and orphan children would be available in the case of assets sQid to raise cash to pay bequests to such transferees. It is submitted, however, that the language of the treasury proposal makes implicit that the exemption would ~n1y be available with respect to property delivered in kind In satis- faction of a bequest to a spouse or orphan child. Such a limitation avoids many complexities and is consistent with the goal of the exemption, which merely is to provide tax deferral until assets are sold by the recipient spouse or child. If the sale is made by the executor, the occasion for such exemption never arises. It is possible, of course, that the executor would be uncertain for some time whether a given asset would be sold, or would be delivered in kind to a spouse in satisfaction of a formula or residuary bequest, and thus would be uncertaIn whether or not the unrealized appreciation of such property would be in- cludible In the decedent's final return. Partial relief `from this problem could be provided by delaying the due date for the decedent's final income tax return until the due date for the decedeht's estate tax return, If the latter date were later (which it normally would be for a calendar year taxpayer who died after July 15). This would also permit use of the alternate valuation In determining the value' Of assets subject to tax with respect to unrealized appreciation. Furthermore, it should permit the Internal Revenue Service to develop pro. ~edures which would integrate the audit of the estate tax return and' the final income tax return so as to avoid the necessity for separate determinations of values for purposes of each tax. The Treasury also proposed an exemption, in effect, for estates not' `required to file a federal estate tax return by providing a minimum basis with respect to unrealized appreciation of assets of $60,000. Such an exemption appears to be unjustified and wholly inconsistent with a policy of Imposing an Income tax on unrealized appreciation at death. The evident purpose of the exemption is to free from that' tax any estate for Which nn estate tax .return Is required. [f the estate' tax exemption remains $60,000, the amouhts involved are too large to apply the same exemption to unrealized appreciation at death If as Is proposed here, the exemption is, reduced to $20,000, administrative con- siderations become more important in relation `to the amounts of tax Involved. At that level, an exemption from tax on unrealized appreciation might also be appropriate. There remains the question of how the Treasury Proposal could properly be applied to unrealized appreciation of assets as of the date of its enactment. The Treasury would have given taxpayers with respect to each `owned asset the option of using either adjusted basis or the value as of the d'atC of enactment, with specified adjustments. It is submitted that this option should, lIke the optional valuation for estate tax purposes, be available only on an aggregate basis. In other words, the executor should be perthitted to make only a single blanket election, applicable to all assets of the decedent, either to use adjusted basis' or value as of the date of enactment as the cost In determining taxable gain. Such a single election would simplify the preparation and audit of the decedent's' final return. It would also limit the extent to which unrealized gains as of the date of enactment would escape taxatIon, by requiring that unrealized losses likewise be taken into account if the executor prefers mot to use cost basis. PAGENO="0529" 515 B. TH1!~ AMERICAN BANKERS ASSOCL~TION PROrOSAL : A~ ADDITTONAL ESTATE TAX (AET) o~ UNREALIZED API~RECIATION OF PflOPERTY TRANSFERRED AT DEATh The American Bankers Association Proposal would Impose a single flat rate of tax on net appreciation included in (1) an Individual's transfeTs at death; and (2) his transfers made In the two years preceding death unless the trans- ferred property is sold before he dies. The suggested rate Is 14%, based on an assumed top estate tax bracket of .60%. As the AET would not be deductible in computing the regular estate tax, a 14% rate corresponds to a maximum rate of 35% on capital gains under the income tax. This follows from the fact that the tax on such gains (whether paid during life or an unpaid claim when the taxpayer dies) reduces the portion of the estate otherwise subject to a 60% estate tax, so that of each 35 cents paid in capital gains tax, 21 cents Is offset by a reduction in estate tax when the taxpayer dies. The single rate has been defended on the ground that a decedent who Is in the assumed top estate tax bracket of 60% "would pay approximately the same total tax as he would pay jf a capital gains tax on this appreciation at death were imposed and a deductiOn for this tax were allowCd in computing the estate tax. All other decedents would pay a smaller* AET than they would pay~ under a capital gains tax at death" (Covey at p. 845). The final, statement appears to be overly broad. For example, a taxpayer who died January 1 might have no income incl~rdible in his final return, under the Treasury pro-. posal, except for unrealized appreciation. Such unrealized appreciation would have to exceed $20,000 for a single taxpayer before any part of it would be subject to a marginal income tax rate on capital gains approaching 14% and would have to be about $50,000 before the average Income tax rate On capital gains would be as high as 14%. And the comparison just mttde does not take into account the reduction In the effective tax on gains resulting from thern estate tax deduction for the tax itself. Thus It does not seem appropriate to use a single rate for the AET which would apply to all estates, without regard to their size or to the percentage represented by unrealized appreciation. A second objection to the proposed AET is the failure to provide an exemp-. tion for appreciation of assets transferred to a surviving spouse on the ground that "as a matter of theory, Imposition of a tax on appreciation should not turn upon the destination or use of the appreciation" (Covey, p. 84d). It is submitted that whatever the theoretical justification for a tax on unrealized appreciation, the practical impact of the tax on a surviving spouse should not' be ignored. To fail to do so Is to force the spouse to pay a tax at.the very time. that the decedent's earning power ceases to be a source of her support. Yet the absence of the exemption is one of the claimed sources of simplicity of the AET in contrast with the Treasury ~rQposal. But the most fundamental objection to the AET Is that it would continue to provide artificial Incentives for some taxpay~ers to retain appreciated assets until they die, because for them the AET~ would be lower than the capital gains tax that would be paid during life (after giving effect both to the loss of deferral with respect to tax paid during life and the removal of the amount of the tax from the gross estate for estate tax purposes) For other taxpayers the AET would provide an. equally artificial Incentive for lifetime sales of' appreciated assets, because for them the relevant comparison Would Indicate that the AET would be the more burdensome* levy. Furthermore, any change in the taxation of capital gains realized during life would also distort such corn parisons unless it were accompanied by a corresponding change in the fiat rate AET. Thus the AET would continue to provide a lock-In effect for some taxpayers and would' create for others an artificial incentive for lifetime sales of appreciated assets. Finally, to call an income tax an additional estate tax Is more than Illogical. It would be expensive for the Treasury as well There are outstanding issues of United States bonds which are eligible for redemption at par in payment of the holder's estate tax when he dies. As of early March, 1976, some issues were selling for as little as 81. This gIves purchasers an opportunity to settle their~ estate tax liabilities for just 81 cents on the dollar, if the . bonds are bought before they die. Of course the 19. cent discount would have the effect of in-. creasing the purchaser's taxable estate, as bonds bought at 81 would be valued at 100 for estate tax purposes to' the extent redeemable at par to pay the estate tax. But `this Increased estate tax `merely reduces the discount the purchaser~ 68-872--76----34 PAGENO="0530" 516 enjoys. Thus the tax on unrealized appreciation at death should not be called an additional estate tax if for no other reason to avoid making it subject to payment at a discount by buyers of redeemable bonds. A further reason which makes inappropriate the designation of an income tax on unrealized appreciation at death as an additional estate tax is the trend for state income tax statutes to follow federal definitions of taxable in- come. [f such appreciation is to be treated in substance as taxable income for federal purposes, the states should not be required to change their income tax statutes to reach a similar result. C. CARRY-OVER BASIS FOil DEATIITIME TRANSFERS No extended consideration of the third alternative, a carryover of the de- cedent's basis for transfers at death, Is appropriate. This approach would perpetuate the lock-in effect of present law, in that taxpayers would know that the tax could be postponed indefinitely if the property were not sold by them or their transferees. It would also perpetuate any uncertainities about basis instead of causing them to be cleared up at the death of the taxpayer if he owns the property at that time. Mr. PIKE. Our tiext witnesses are both here from the Printing In- dustries of America, Mr. Frank B. Reilly, the general counsel, and Mr. John F. Grant, the Director of Government Affairs. I do~a't know whether you are both planning to speak, but, which- ever one of you is, please proceed. STATEMENT OP PRANK ~. REILLY, GENERAL COUNSEL, ACCOM- PANIED BY JOHN P. GRANT, DIRECTOR, GOVERNMENT AFFAIRS, P~tINTING I1~DUSTRIES OP AMERICA, INC. Mr. REILLY. Thank you, Mr. Pike. My name is Frank B. Reilly, Jr. I am associated with the Washington, D.C., law firm of Counihan, Casey & Loomis, the general counsel to the Printing Industries of America, Inc. .1 am accompanied on my left by John F. Grant, Di- rector of Government Affairs for the Printing Industries of America. The Printitig Industries of America, Inc. (PTA) is a national federation of regional state and city trade associations representing approximately 8,000 member commercial printing companies in the United States. PIA is the world's largest graphic communications association and in the 90-plus years since its foundation has evolved with the rapid growth of a vastly technical service industry known as "American Printing." The aggregate sales volume of the printing industry is approxi- mately $25 billion. PTA members account for over 75 percent of this vo1up~e and employ approximately 350,000 highly skilled graphic arts craftsmen. While the industry ranks first in the number of individual establishments of the leading twenty manufacturing industries in the United States, and seventh in total dollar payroll, 80 percent of the printing companies consist preponderantly of small closely-held businesses with twenty or fewer employees. The overwhelming ma- jority of these small printing businesses are tharacterized as closely- held family businesses. lJnforunately, these small printing compa- nies, like other small businesses in other industries, are often either undul~t burdened or indirectly discriminated against in the applica- tion of~our tax laws. This situation is acute and is in need of legis- lative remedy. Failure to address this problem will seriously weaken the traditional small closely-held business, which in the aggregate, PAGENO="0531" 517 Tepresents the vitality atid~ bedrock of our competitive free enterprise~ ;system. We are grateful to the committee for the oppo~'tunity to. present the views of PIAon the subject of estate tax reform. The members of PTA consider this subject important and have collectively expressed their deep concern that because of today's ecduornie climate and our present estate tax system, the typical small printing business may be forced to liquidate, merge or be sold under unfavorable market terms in order to meet potential estate tax obligations. This will usually result in unfortunate cash demands on the heirs of the principal owner of a small pTinting company and preclude the perpetuation of the business by the family. The members of PTA recognize that a forced divestiture of a family busine~s may be avoided under certain circumstances with proper estate planning~ However, in many instances the necessary capital to fund anticipated cash demands of an estatO of a~ small printer is nonexistent due to the pressing working capital d~rnands of his business. Diversion of personal funds otherwise earmarked for anticipated future business needs may disrupt the capital reqi~iire- * ments of the business, and, in some cases, delay future capital im- provements. Thus, many small printing companies, which are typ- ically capital intensi~ve, run the risk of forced liquidation to satisfy estate tax obligations undeT circumstances where even sophisticated estate planning techniques would not alleviate the problem. Recognizing the small closelyh~id business profile of the printing ~industry, we shall limit our comments to three specific areas of estate ~tax reform which, in the opinion of the members of PTA, would dramatically . iniprove the opportunity for the future preservation and continuity of the small, closely-held ~printing company and, at the same tithe, proi'ide an incentive for further small btismess for- * mation and increased competition. 1. INCREASE IN THE ESTATE TAX EXEMPTION The eff~ct of inflation and the retention of the $60~000 estate tax exemption is the primary contributor to forced divestitures of fam~ fly businesses to satisfy estate tax obligations The current $60,000 exemption was established in 1942 and has remained at that level despite the .~general escalation of the price level and, decline in tile purchasing power of the dollar. Indexing the $60,000 exemption for changes in the consumer price index since 1942 would result in an exemption for 1976 of approximately $200,000. This figure would reduce the impact of the estate tax on the perpetuation of small, family businesses. The reveni~ie los~~ associated with an increase in the exemption to $200,000 would require study, but if the revenue un- pact may be reasonably justified, the estate liquidity problems of small, closely-held businesses will be dramatically improved. Accordingly, we recommend that the present estate tax exemption of $60,000 be increased to $200,000. 2. INCREASE IN THE MARITAL DEDUCTION The marital deduction was enacted in 1948 and has remained un- changed to the present. The effect of this deduction is to allow one PAGENO="0532" 518 `spouse to transfer one-half of his adjusted gross estate to his surviv- ing spouse without incurring the estate tax on the transfer. We feel that it is important to emphasize that many small busi- nesses are family integrated in the sense that the operation of the concern is dependent upon the ability and skill of each family mem- ber who is active in the business. Also, the business is usually man- aged with the objective that one spouse will perpetuate the business within the family unit upon the death of the first spouse. Unfor- tunately, the financial demand on the estate of the first spouse to die as the result of the estate tax on the value of the business interest passing to the surviving spouse has seriously impeded the perpetua- tion of these family integrated printing companies beyond the life `o~ the principal founder. Further, if the business is continued by the surviving spouse, the estate tax on the value of the business `interest passing at his or her death would appear inappropriate since the integrated business would be subject to a second tax. This practice may result in the family unit facing a possible liquidity crisis with respect to the same busi- ness on two occasions with the likelihood that a divestiture of the business will result. We note that several proposals are now pending before this com- mittee to provide an unlimited marital deduction. These proposals would substantially alleviate the financial burden of the family unit upon the death of the first spouse and also address the integrated nature of closely-held family businesses. However, since we are not in a position' to assess the revenue impact of these proposals nor their effect upon the liquidity problems of perpetuating a family business from one generation to another, we commend further consideration of these proposals to your committee. As an alternative, we support an increase in the marital deduction to $100,000 plus one-half of the adjusted gross estate in excess of $100,000 in order to minimize the cash demands upon a small family business on the death of the first spouse. This proposal, in conjunc- tion with an increase in the estate tax exemption to $200,000, would effectively eliminate the need for most small fa~aily businesses to ~utilize an estate plan in order to avoid liquidity demands and forced ~`divestiture problems. 3. LIBERALIZATIoN OF TIlE ESTATE TAX PAYMENT RULES A. Section 6166 To alleviate the liquidity problem of a decedent who owns a sub- stantial interest in a closely-held business, Section 6166 presently al- lows an electvie 10 year installment payment of the estate tax at- tributable to an interest in the closely held business. Because of the mechanical eligibility tests of section 6166, the exec- utor's personal bonding requirement and the increase in the interest rate from 4 percent to the present 7 percent rate, many estates have not utilized the 10-year installment payment procedure although ad- ~vantages to a family closely held business may have existed. To make section 6166 more attractive to closely held businesses, a proposal ha~ been ~submitted to enable estates with a closely held business interest otherwise qualifying under 6166 to postpone pay- PAGENO="0533" 519 ~nent of the estate tax attributable to the first $300,000 of the closely held business for 5 years, followed by an optional payment period over the next 20 years at an interest rate of 4 percent per annum. We support this proposal as a viable means of enabling an estate with a substantial interest in a closely held business to pay the e~tate tax out of the earnings of the business over a sufficient period whereby the perpetuation of the business will be reasonably assured. Furthers the return to a 4 percent per annum interest rate is consistent with the original congressional intent for a reduced rate o~ interest under section 6166 to discourage corporate mergers and maintain the free enterprise system. We also recommend that the 35 percent of gross estate and 50 per- cent of taxa~ble estate eligibility tests be libef~álized in order to make section 6166 more attractive. Further, we recommend that the share- hoder limit be increased to at least 15 and the requirement for a personal bond by an executor be replaced by the use of a security arrangement with the decedent's closely held stock serving as collat~ eral. This latter proposal would also apply to extensions in the pay- ment of estate tax granted for hardship. B. Section 6161 (a) (2) This section provides a procedure whereby upon the showing of ~`undue hardship to the estate," the Commissioner will permit the time for the payment of the estate tax to be extended for a resonable period not in excess of 10 years. The regulations promulgated nuder this section expressly authorize the application of the undue hard- ship provisions in situations where section 6166 previously discussed does not apply due to a failure to satisfy the percentage requirements of that section. Also, forced sales of closely held businesses are recog- nized under the regñlations as situations where undue hardship in the payment of the estate taxes may exist. However, as the result of the administrative difficulty in establishing undue hardship, section 6161 (a) (2) is a discretionary procedure and its usefulness to estates comprised of a substantial interest in a closely held business has been marginal. Accordingly, because of the subjective and administmtive problems associated with the application of section 6161 (a) (2), we recommend that the word "undue?' be eliminated from this section to enable per- missive extensions upon a bone fide showing of hardship to the estate. This recommendation would provide a viable alternative to the mechanical eligibility requirements of section 6166 and also improve the opportunities of airoiding forced divestitures of closely held busi- nesses to satisfy estate tax obligations of the principal owner of the business. C. Section 6621 Prior to July ~I, 1975, an extension for the payment of estate tax under section 6161 (a)(2) and section 6166 was subject to a special 4 percent annual interest rate. This spethal rate was eliminated by Public Law 93-625 and now all extensions are subject to section 6621 which provides a floating interest rate equal to approximately 90 percent of the adjusted prime lending rate charged by banks Cur~ rently, extensions for the payment of estate tax are subject to a 7 percent annual interest rate. : PAGENO="0534" 520 We recommend that the special 4 percent interest rate for exten- sions for the payment of estate tax under sections 6161 (a) (2) and ~166 be restored to enable an estate comprised of a substantial inter- est in a closely held business to pay the deferred estate tax out of the earnings of the business without upsetting the future operation of the business or forcing a divestiture of the closely held business interest. We concur with the congressional intent of the original 4 percent interest rate that this provision is particularly important in preventing corporate mergers involving closely held businesses. CONCLUSION Mr. Chairman and members of the committee, on behalf of the Printing Industries of America and its members, we wish to thank you for giving me the opportunity to present the views of PIA before this distinguished committee. We believe that if our estate tax re- form proposals were enacted, the small printer and his family will be more likely to avoid the liquidity problems occasioned by our present estate tax law and perpetuate the small printing company which, in our opinion, is a vital component of our compentitive free enterprise system. Thank you. The CHAIRMAN. Thank yOU, Mr. Beilly, for a very well delivered and well-thought-out statement. Mr. Grant, did you have some additional testimony? Mr. GRANT. No, I do not, Mr. Chairman. I am available for ques- tions later on. The CHAIRMAN. Our next witness then is Mr. John C. Davidson,. of the Tax Council. We are happy to have you back, Mr. Davidson. ST4TEMENT OP 3OHN C. DAVIDSON, PRESIDENT, TEL TAX COUNCIL Mr. DAVIDSON. Thank you, Mr. Chairman. I am John C. Davidson, and I appear here on behalf of the Tax Council, of which I am presi- dent and a director. From the council's inception nearly a decade ago we have stressed the benefits which would flow to the public from a tax policy less adverse to capital accumulation and preservation. We actually prepared for this appearance 6 years ago when we understood the Ways and Means Committee would undertake a thorough inquiry into the taxation of estates and gifts in 1971. My complete statement, which you have before you, is an undated ver- sion of the program we prepared at that time. I will just skim through it in my oral remarks. Whether estate and gift taxes are paid from liquid assets or by liquidating property, the result is to convert capital into current Government spending. This process violates the economic rule that taxes should be derived from the stream of production and not by diminishing the capacity to produce. The rule of course is grossly violated by the very high rates which `were first legislated in the 1980's when national policymakers were prone to believe that the depression had been caused by oversaving. However, the state purpose was simply to raise revenue. I Today, no one would argue that a society could advance by de- vouring its capital. An economic reality which is so often overlooked PAGENO="0535" 521 is that capital taken and consumed by~Governmeut must be repla~ced out of current income before there is net addition to the nation's stock of capital. The yield of estate and gift taxes is estimated at $6 billion in fiscal 1977, which may not seem like much in a $400-billion-plus budget. But it takes the savings from $100 billion of personal income to re- place the capital taken by thesetaxes each year. Or, stated another way, the value to the Nation of the savings of 1 millions of its citi- zens is canceled out by theestate and gift taxes. Although the history of estate and gift taxation shows a legisla- tive aim limited to raising revenue, the academic dialogue tends to assume and support additional aims. The major aims are considered and rejected on pages 3 and 4 of our complete statement. The one so often used, redistribution of wealth, is not rational. These taxes de- stroy wealth. They do not redistribute wealth. The academic aims generally are based on the assumption that wealth indicates capacity to pay tax; an `assumption which overlooks the far greater revenue potential of taxing income generate4 by wealth than by taxing the wealth itself. The council proposals are designed to progressively lighten the burden of the estate and gift taxes over a decade while maintaining the `present level of revenue from the source. Specifically, these pro- posals would: First, reduce the rates of estate and gift taxes 50 percent over the 10 years through a series of annual cuts in a uniform pattern. Second, permit testators or `donors to place income-producing prop- erties in "tax payment trusts," thus providing for payment of tax from income while conserving property intact. The maximum time of payment of taxes through a trust would be 12 years. Third, provide a credit for lifetime taxes on. capital gains against deathtime taxes on estates. Fourth, average gift taxes over 5 years in place of the cumulation during lifeunder present law. Fifth, increase the marital deduction for estate and gift taxes, now 50 percent, to 100 percent. Sixth, permit gift splitting with respect to deathtime tr~usfers as is now done with respect to lifetime transfers. Seventh, give low priority to proposals for increasing exemptions and exclusions and for extra reduction in the lower rates. Eighth, avoid changes in the law which would increase the burden of estate and gift taxes through various means. Each of these proposals is discussed in some depth. on pages 7 to 16 of my complete statement. ~y allotted time here will permit com- menting further on only a few points. With respect to the proposal for tax payment trusts, with a sharply restricted exception, there is no substantial escape as regards l~rge estates from the design for payment of estate tax liability by liqui- dating property. The exception is in the case of closely held busi- nesses. The law provides that theY estate tax attributable tc such a business may, under tightly defined conditions and at, the election of the executor, not the testater, be paid in not more than 10 yearly payments. PAGENO="0536" 522 Although the objective of the provision is sound, a major difficulty with its use is that it keeps the estate open for the duration of the payment schedule, thereby increasing the cost of administration and prolonging the executor's exposure to liability for tax payment. In addition, the provision grants valuable rights to one class of income-producing property-closely held businesses-while with- holding such rights from all other classes. Yet, the reason for the provision must not be that of special virtue of the testator or legatees directly involved-the reason must be the public interest in pre- serving intact the capital in a business. From this point, there is in fact no line of demarcation based on size or breadth of ownership between capital which does or does not serve the public. The public benefits from the existence of capital employed in an enterprise regardless of its size or whether it is closely or widely owned. The individual who builds an estate apart from his vocation by steady investment serves the public just as much as the individual who develops a business. There is no way to draw a line of public interest in use of capital short of the Na- tion's total stock of capital. By use of tax payment trusts, the council proposal would permit the ownership interests in any income-producing property to be transferred to whomever-managers, employees, or others regardless of family ties. Some details and information with respect to this proposal are given in exhibits A and B, but three important points are: 1. The testator would direct, or the donor in the case of lifetime gifts would make, the necessary arrangements. The executor would not have the power to create or void a trust, or the responsibility for its administration. 2. The property placed in trust would become the total security for payment of the tax. attributable thereto. 3. Approval of a trust by the IRS would constitute discharge of the tax liability insofar as administration of the estate is concerned. Two other proposals of the council run directly counter to those of the conventional tax reform school, namely: the proposal for a 5- year averaging of lifetime gifts, and the proposal of a credit for. lifetime capital gains taxes against deathtime estate taxes. The opposite proposals are that gift and estate taxes be unified and cumulated, and that unrealized gains at death be subject to tax in addition to the estate tax. There is ,a vast difference between the act of a person . who in the prime of life permanently foregoes further use of property by giving, it away and the act of a person in provkling by will for the dispo- sition of property come the time when he can make no further u~e of it.; By. contrast, when property is sold, the seller's capital worth is diminished only by the amount of the capital gains..ta~x. Unless other forces intervene, there is no break in the continuity of ownership before death except for the. part taken away by the capital gains tax. The Council's position is that contihuity in ownership of capital in whate~er form through life and until disposed of at death pro-., vides a connection between tax on lifetime transfers and on the final transfer at death which should be reflected in a credit of the former PAGENO="0537" 523 against the latter. By the same. reasoning, there is nothing whatso- ever to connect up between lifetime gifts and the, transfer of prop- `eFty still owned' at death, and~thus there is no rationale' for connecting tip or unifying the taxes paid on the two By the allocation plan we have: proposed, the estate and gift taxes `would be yielding the same revenue 10 years hence as at present- $6 billion. Th~ appearance, however, of a $10 billion revenue loss would not be so What the government gave up in estate and gift tax revenue it would be' reéouping in income and excise taxes on the capital left in the economy. Estimating the revenue take through these taxes at 30 percont of `GNP generated by the resulting capital formation, the total would be itearly $8 billion in the tenth year It would increase to over $10 billion in the twelfth `year, an~ the in- crements thereafter would be all plus values. in conclusion, looking back, `we may wish the legislators of a pre- ceding era had displayed greater econOmic sophistication than re- .flected in the rates held for nearly 40 years. At least they stated their objective as simply that of raising' revenue. We commend the same objective to this committee, but with an important difference. We urge that you recognizo and give effect to the fact that"pei~mitting more capital to generate more income will, among other good pur poses, raise more revenue than would be raised by taxing the capital directly. . I thank you. The CHAIRMAN. Thank you very much, Mr. Davidson. Without objection, your full statement and supplemental materials and the various charts and graphs will be included: in the record. I want to commend you' for a very thorough statement. [The prepared statement and supplemental material follow:] StATEMENT OF JOHN C. DAVIDSON IN BEHALF OF TImE T~x CotNcIL TOWARDS A TAX POLICY LESS ADVERSE TO CAPITAL My name is John C. Davidson. I appear here in behalf of Th~ Tax Council of which I am President and a Director. The Council is a noni~i~oiit, tax policy organization supported by business. From its Inception nearly a decade ago, the Council has stressed the benefits which would floW to the public from a `tax policy `less adverse to capital accumulation and preservation. We prepared for `this appearance nearly `six years ago. At the time, 1970, it was understood the Committee on Ways and Means would undertake a thorough inquiry into the taxation of estates and gifts beginning in 1971. The Council's Tax Policy Committee therefore gave the subject priority' attention and, on October 21, 1970, approved A Program to Reform Estate and Gift Taxes which I bad prepared for its consideration. My statement today is an `updated version of that program. Economies of Estate and Gift Taa,es Whether estate and gift tares are paid from liquid assets or by liquidating property, the result is to convert capital intO current goternment spending. This prpcess violates the economic rule that taxes should be derived from the stream of prodfiction, and not b~r diminishing the capacity to produce Little thought seems to hate been given to this rule when the extremely high ra'tes of estate and gift `taxes `Were first legislated in the 1930's. At the time, national policymakers were prone to believe that the depression bad been caused by oversaving. This belief undoubtedly was a factor among those who voted the high rates, but th~ stated purpose for the levies was simply to raise revenues. The fact the rates would require effective liquidation of large PAGENO="0538" 524 `estates (`unless preserve4 through philanthropic transfers) seems to have `caused little concern. Today, no one would argue that a society could advanen by~ devouring its `capital-which is what happens when capital is converted by taxation to gov- ernment spending. The amount so consumed must be replaced out of current income before there is net addition to the nation's stock of capital. The yield' of estate and gift taxes, estimated at $6 billion in fiscal year 1977, is not of great fiscal importance in ~ budget In which spending will exceed $400 billion and revenues $350 billion. And it Is only six percent of the estipiated rate of personal savings. But, for perspective, the figure is best related to the amount of income and numbers of people Involved in it~ re- placement. Specifically, the savings from some $100 billion of personal income are re- qtiired to replace the capital taken by estate and gift taxes. Or, stated another ~way, the value to the nation of the savings of 14 millions of its citizens is cancelled out by these taxes. 1970 was a period of intense public di~cussion of national priorities. We pointed out then that when a claim for priority was examined, it was feund that the need was essentially for more capital. Continuing, we said: "The dialogue on priorities has tended to aSsume that the overall shortage of capital is something which must be aec~pted and lived with, but the `Council view is that the dialogue* `adds i~p to a formidable case for' priority atteution to ways and means for increasing the nation's stock of capital. A good place to start is where taxes now destroy capital." Since then, a consensus has developed tl~at capital spending as a percentage `of gross national product should be increased, and it is widely recognized `that reduction in the `tax impact on capital' is necessary to this end.1 Objectives of Estate and Gift Tacvation Although the history of estate and gift taxation shows a legislative aim `limited to raising revenue, the academic dialogue tends to assume and ~support additional alms. The most prominent one is redistribution of wealth, some- times stated as reducing the concentration of `Wealth. Another is the taxation `of windfalls. And still another is to tax wealth~per se on the assumption its existence indicates capacity to pay tax. Superficially, the redistribution aim might seem consistent with the common law rule against perpetuities which originated in Medieval England. The aim, `however, is unrelated to and inconsistent with that ancient rule. The rule was concerned with limiting the power of a living individual to control future `inheritance while the redistribution aim is concerned with limitng the amount of property whch may be inherited. The aim Is Inconsistent with the rule be- cause it ~would accomplish the reduction of wealth in particular hands by destroying It, whereas the rule was concerned with freeing the movement of property beyond the living generation and not at all with destroying it. Unfortunately, the dialogue does not illuminate the problem of concentration of wealth in contemporary America, or tell us why estate and gift taxation would be a good instrument for dealing with such a problem, if it does exist. There are several factors which mitigate against the existence of the prob- lem: first, the amount of wealth passing by testament or gift in any year is only a fraction of our total wealth and is small in relation to the contemporary rate of accumulation; second, just as the accumulation of wealth means the creation of new and better jobs and higher living standards for the public at large, so does the conservation of wealth assure an ever higher base from which to build; third, the American work ethic seems to be more enhanced than dulled by accumulated wealth; and fourth, in the open, viable American society, ostentatious display of wealth is not a social or political problem. `The view of the Council therefore is that there Is not a major problem of concentration of wealth in contemporary America. If there were such a prob- lem moreever, the tax mechanism would be an inappropriate instrument for dealing with it because taxation destroys instead of redi~trlbuting wealth. 1 A proposed national policy goal `for raising the level of gross capital spending from `the long time average of 151/2 percent to 17 percent of gross national product, through `a comprehensive program of capital-releasing tax reforms, Is spelled out In the December 1~75 revision of the Council's "Program for a Stable, Capital Conscious Federal Tax `Policy." PAGENO="0539" 525 There is a view among tax scholars that consideration should be given to transforming the present taxes into an accessions tax to be paid by traus- ferees on a cumulative wealth basis. For example, a legacy of $10 million going to a person without pj~ior wealth would be taxed from the bottom of the rate scale up, but such a legacy going to a person who already was worth $10 millioa would be taxed off the top of the scale. The Council believes it much better to concentrate on lightening the destruction of capital under the present system than to become involved in developing what inevitably would be a much more complicated but also a more destructive system of taxation. With respect to the aim of taxing windfalls, this seems a poor way to de- scribe the great bulk of transfers which inevitably go to relatives or others who have reason to expect remembrance. This aim may be dismissed with the observa~ioh that It seems as oblivious to bonds between human beings as it is to the Importance of conserving capital to serve the public Interest. The assumption that wealth Indicates capacity to pay tax overlooks the far greater revenue potential Of taxing income generated by wealth than by taxing the wealth itself. It Is ~ne thing to use wealth as the measure of tax we expect to be paid out of income, as with local property taxes, but is quite another to look on the wealth itself as a major tax object. The present rates of estate and gift tax may be tolerable because such a small part of the nation's wealth is subjected to this taxation in any one year. This does not change the fact that the rates are uneconomic, destructive and quite Inimicable to the public interest in maintaining and expanding `the nation's stock of ~eapital. General ~nmmary of Progr.~m The estate and gift taxes deprive the private economy of the growth, new jobs and other values which would come from a sIx percent Increase in per- sonal savings, and deprive the government of the increase In the income tax base which would come' therefrom. The broad objective of the Council pro- gram is a restructuring of the ~state and gift tax system to reduce the amount of capital converted to government spending, and thus to enlarge the bases for economic growth and for income taxatiofl. The key proposals would: (1) ProgressIvely lighten the burden of these taxes over a period years with- out reduction In the dollar amount of revenue from this source, and (2) ProvIde a practical means by which taxes due with respect to income- producing property would be derived from the income and not from the prop- erty Itself. A number of other proposals are designed to Improve the structure of the estate and gift tax sy~tem whil~e avoiding revision which would subject affected property to greater' taxation. E~Iummary of ~S~pecifle Policy Proposals In brief, the Council program would accom~plish the following results. (1) Allocation of Revenne Growtk.-Revenue growth from the estate and gift taxes would be allocated for. a decade ahead to rate reduction and other capital-saving reforms. (2) Ten-Year Plan of Rate Mo~ration.-~--The rates of estate and gift taxes would be reduced fifty percent over ten years through a series of annual `cuts in a uniform pattern. (3) Taco Payment Trusts.--All testators or donors would be permitted to place income producing properties in "tax payment trusts", thus providing for payment of tax from Income while conserving property Intact. The maximum time for payment of taxes through a trust would be twelve years. (4) Credit for Capital Gains Tacoes.-A credit would be provided for life~ time taxes on capital gains against deatbtime taxes on estates. (5) Five-year Averaging `of Gift Tacves.-To permit greater flexibility as re- gards both the timing and amount of gifts, gift taxes would be averaged over a period of five years in place of the cumulation during life under present law. (6) Carryover of Capital Gains in Case of Gifts.-Because. the carryover of capital gains basis does not seem to discourage giving during life, there would be no change Ifi law In this respect. (7) Marital Decluetion.-The marital deduction, now 50 percent for both estate and gift taxes, would be increased to 100 percent. PAGENO="0540" ~26 (8) Gift-Splitting with Respect to Deathtime Transfers.-Tbe splitting of gifts between spouses as permitted in lifetime transfers woud be extended to `de~thtinie transfers. (9) Low Priority for Other Ta~aving Proposols.-Proposals to increase ex- emptions and exclusions and for extra reduction in lower rfltes are accorded low priority in the'Council program. (10) Separate Taa'ation of `Estates and Gifts.-Contemporary proposals for unifylhg and cumulating these taxes under one rate scale would discourage lifetime giving, and thus under the Council program would not be enacted. (111) Avo'k1l~5ij New or Additional ~aa~ation.-Proposals for increasing the burden ~f estate and gift taxes through various `meaus-ipeluding additional taxatioh for so-c~tlled gèneratio~ skipping, comparable taxation of property transferred to `noñrelatives, `a~nd inclusion of employee death benefits in gross estates-run counter to the public Interest `In conserving ckpital or are other- wise objectionable, and thus are opposed in the Council program. There follows a' ~i~cussion of the Council proposals jn some depth. 1. Allqcatlon of Revenue Growth Estate and gift taxes are now yielding annual revenue Of about $0.0 billion, and experience would indicate an average Snnual growth in tax base of at least ten percent. The Council propOsal is that the federal government forego for a decade the revenue Increase Which would come from this growth in base~ This would Sliocitte $600 million a year for rate redUctions and other tax-sav- ing reforms of the estate and gift taxes. Although this is a small or even insig- nificant sum in relation to current budget levels-about one-seventh of one percent-over a decade the contribution to capital formation would be sub- stautlal. Tf present rates were continued, a ten percent annual growth in base of the est~tte and gift taxes would push revenue from this source up to $16 billion a decade hence. It would take the savings from nearly $270 billion of personal income, to replace the $16 billion before there was n~t addition to the nation's stock `1~ capital. By allocating the. revenue growth to tax reduction., these taxes a decade hence would still be yielding Only $6 billion annually. A quick reaction might be that the government therefore would be losing $10 billion a year in revenue as the result of enactment of the program, But this would not be so. While the government would be getting.$10 billion less a year from the estate and gift levies, it would be reaping through the income and excise taxes the benefit of $10 b~llion,in capital formation. Estimating the revenue take through these taxes at 30 percent of the gross nationa' product generated by the capital formation, the total would be nearly $8 billion in the tenth year. The revenue yield would increase to over $10 billion in the twelfth year, and the incre- ments thereafter would be all plus values. 2. A Ten-Year Plan of Rate Moderation Estate tax rates begin at 3 percent on the first $5,000 of taxable estate, reach 30' percent at $100,000, move from 49 to 53 percent at $2,500,000 and reach a top rate of 77 percent at $10,000,000. Gift rates are a uniform three-quarters of the `estate rates. The' rates and amounts of tax at the turn of each bracket are given In Tables I and II. The ten-year plan contemplates a cross-the-board reduction of 50 percent in the `rates of `estate and'gift taxes at the end of the period. One means of doing this would be to reduce rates a uniform five percent of present rates in each of the ten years. However, because the base for these taxes grows yearly (1t~ percent), a uniform rate cut would not coordinate with maintaining revenuea from this source at a level $6 billion over a decade, releasing $600 million a year for rate reduction and other reforms. A five percent cut in rates would reduce revenues only $300 million in the first year but $800 million in the tenth year. The other means for reducing the rates on a uniform pattern would be to apply the same percentage cut each year to the declining rate scales. Roughly, seven percent would accomplish the objective. This would encumber about $420 million out of the $600 million available annually for reducing the burden of these taxes, leaving $180 million a year on the average for other reforms. The 77 percent top rate of estate tax would be reduced to 38.5 percent in the following progression: PAGENO="0541" 527 `~`~ Year~ Rate (percent) Year Rate (percent) i 71.8 6 51.0' 2 66.9 7 47.3 3 62. ~ 8 44.2 4 58.0 9 41.4 5 54.3 10 38.5 The rates fpr all brackets o~ the estate tax after each annual reduction are shown in Table III. ó'. Tan' Paymen,t Trasts With a sharply restricte~1 exception, there is no substantial escape as regards large estates from the design for payment of estate tax liability by liquidating property. The marital deduction will, generally delay but not prevent full pay- ment of the death levies, The tax may be avoided by philanthropic transfers `of property, but this cuts out the natural heirs or others to whom the testator might have liked to transfer property intact. Without liquidating part of the property, he is unable to tran~fer ownership to sons, daughters or others. If he wishes his property preserved Intact, he is stopped from transferring It to those he would like to assume the responsibilities of ownership and manage- ment. The e~ceptlon to the design of liquidation is In the case of closely held businesses, The law provides that the estate. tax attributable to a closely held business may, under tightly defined cOnditions and at the election of the executor (not the testator), be made in not more than ten yearly installments~ The conditions are that the value of the estate's Interest In the business exceed 3~ percent of the, value of the gross estate or 50 percent of the taxable estate; that the ownership interest be not less than 20 percent of the stock of the corporation; and, `in the latter case, that there be not more than ten share.. holders. Although this provision seems to have received less use, than contemplated when enacted, its purpose-an unqualified departure from the design for tax payment from liquidations of property-is sound. Other than the restrictions, major reasons why greater use ha~ not been made of the provision Is' that it keeps the estate open ,fQr the duration of the payment schedule, thereby In~ creasing cost o~ administration and prolonging the executor's exposure to liability for tax payment. Nevertheless, the provision for installment payment, of estate taxes con- stitutes a precedent or principle as broad as the public Interest In preserving capital. The reason for' the provision is' not special virtue of the testator or legatees directly affected, but `the public interest~ In preserving intact the capital in a business. While the provision was enacted because business groups bad pointed to `the hardship of the estate tax on ~ma'li, closely held buslnesse~, from the public standpoint' a given amount of capital invested in a small business is of no greater Importance than a similar amount invested in a larger business. `In fact; the provision as enacted is in no sense restricted to small businesses. If the conditions are met, `there Is no limit to the size of a business which may qualify as a closely held business under the provision; There is in fact no line of demarcation based on size or breadth of owner- ship between capital which' does or does not' serve the public. The public bene- fits from the existence `of capital employed in an enterprise regardless of its size or whether it is closely or widely owned, There is no way to draw a line of public interest in use of ca1pital short of the nation's total stock of capital. To consetve capital' which ~otberwI~e Would b~ cpnverted by e~tate or gift taxes Into government spending, therefore, the C9uncil's proposal Is that pro- vision be made for payment of estate and gift taxes generally out of income from the affected property Instead of by liquidating part or all of the prop- erty. This would, mean that any ownership interest in any income-producing property could b~ transferred intact to managers, employees or others regard- less of family ties or whether a bUsiness is small or closely held. The property involved would be placed in "tax pa3~)uent trusts," the sole purpose of `which Would be to collect the income from t~e property and pay the tax attrl,bntable thereto. When the taxes were fully `paid, the trust would be terminated and the ti'ansfer of the property completed, Details Of the proposal, "and some comthents in regard to revenue effect~ as developed six years ago, are set forth in Exhibits A and B, respectively. PAGENO="0542" 528 4. Credit for Capital Gains Taa'es against Estate Tc&wes at Death? A problem generally associated with estate taxation is the appreciated value of property held at death. This value, generally referred to as "unrealized gains," is not subject to the capital gains tax. A common proposal has beeii that, through one means or another, such gains be brought into a tax base. One proposal would tax the gains by requiring inclusion in the decedent'a final income tax return. Other proposals would tax the unrealized gains under the estate tax system. Whichever way it might be done, the taxation of un-~ realized gains at death would mean a double simultaneous impost on a transfer of capital. The Council's approach to the problem is quite different. Instead of impos-~ ing a double tax at death, it would provide a credit against estate taxes of capital gains taxes paid during life. This would eliminate the double tax which now results from ~ayiug estate tax ~n property which in one form or another has been subjected to capital gains taxation one or more times during the decedent's life. The credit is a key proposal of the Council program for reform of capital gains taxation which would take the pure capital gains ot individuals out of the federal income tax base. Under the program, such gains would be taxed under a separate system of transfer taxation associated with the other federal capital transfer taxes, that is, those on estates and gifts. The credit at death would reflect the fact that the tax object is capital. and~ not income. Of course, the credit should be provided for gains taxed under the income tax law if the transfer system Is not adopted. 5. 4 Five-Year Averaging of Gift Tawes Because a person's capital is diminished by the amount of his gifts ,and the tax thereon under present law) and gifts In different periods of his life may have no relation whatsoever to each other, it coflid be argued that these transfers should be taxed annually without cumulation. There is continuity in plans for giving, however, which extends over years even though each gift separately breaks continuity of ownership. As a middle proposition, it is sug- gested that gift taxes be averaged over . five years. This would encourage giving earlier, more often and in greater total amount during life. In some cases, there undoubtedly would be a spreading out of gifts beyond five years to benefit from lower tax rates, but this would serve the pitblic interest in lightening the burden of taxes on capital. 6. Continned Carryover of Capital Gains Basis in Case of Gifts Under present law, unrealized gains on gifts during life do not become tax. free as happens with respect to deathtime transfers. The donee takes the tax basis of the donor and, if he subsequently sells the property; pars tax on the appreciation in value from the time the property was acquired by the donor. Proposals for unifying estate and gift taxes2 and for paying tax on appreciated value at death generally contemplate that donors would pay tax on appreciated value at the time of giving. Tb~ result inevitably would be to discourage giving. The approach of the Council's program Is that more giving during life is generally desirable but not if the tax consequences would convert more capital to government spending at the expense of the needs of the private economy. The carryover of capital gains basis in the case of gifts does not discourage giving as regards time or amount, and therefore should be continued. 7. Increase in~ Marital Deduction Under present law, the ma~itai deduction is 50 percent of each lifetime gift between spouses, and 50 percent of the adjusted gross estate of a deceased. spouse. There is a view with considerable support among tax authorities that this or any limit on free transfers of property between spouses violates the mutuality of the marriage bond or, stated differently, any tax on transfers be- tween spouses is an inappropriate exercise of the taxing power. Because the 50 percent deduction is so genGrally availed of under present law, thereis some concern that change in the law to permit unlimited tax- free transfers between spouses would create a strong incentive to disregard the facts and circumstances which would indicate only partial transfer in individual situations. In joining in the proposal to raise the marital deduction. to 100 percent on all interspousal transfers, the Council hopes that the incen-~~ 2 See Section 10. PAGENO="0543" 529 tive created will be for more objective evaluation of all the factors before the~ deductions to be taken are decided. 8. Gift-S'p~itting wwt Respect to Jieatlitime Transfers IYnder `pr~s~nt' law, a gift by a married person to someone other than his or her sptaise may be treated taxwise a~ If half had been given by the other spduse. This splitting of gifts, however, is not permitted as regards testa-~ mentary bequests, Iti other word,s, the. ~urv}ving spouse canilot take one~half of the gift's value out of the estath and treat it as a gift by him or her. The Council joins In the proposal initiated by others that the privileges of gift- splitting be extended to deatbtir~ie'transfers. 9. Low Priority for Proposals to Jncrease Etvemptions and ~Ja~ölusions, and for Jijciytrcs Reduction in Lower Rates. The Council program aCcords top priority to reforms in estate and gift taxes which would be ntost significant for conserving and enlarging the na- tion's stock of capital. When the estate and gift taxes are reviewed from the standpoint of direct impact on people, `howe~rer, instead of impairment of the nation's stock of capital, there is a tendency to dwell on marital arrangements, exemptions and exclusions and the level of rates on taxable amounts up through a few b~undred thousand dollars. The adequacy of marital arrangements is the only one of these areas to which the Council program accords priority. Even with a 100 percent marital* deduction, it is believed the revenue effects of the complete program would not average more than the ~600 million annual revenue growth in the estate and gift area which it is recommended the ~ovêrnment forego for a decade to accomplish reform. If offi~1al estimators should conclude that the program would fall significantly short of encumbering all of the revenue growth, acceleration in rate reduction would be the most desirable additional option. In other words, until the values in the public interest emphasized in its proposals have been largely achieved, the Council believes that low priority should be accorded propc~sals for increasing exemptions and exclusions and for extra reduction in the lower rates of tax. Three factors are esi~eciálly significant to these conclusions. First, the pro- posed rate reductions weuld substantially~ ease the burden of tax In the lower ranges of estates and gifts with the major part of the reductions coming in the early years of the program. With the recommended seven percent annual reduction applied to the dacliñing scale of rates, nearly two-thirds of. the overall fifty percent reduetlofl would take place in the first five years of the program. For example, as shown in Tabl~ III, the 30 percent rate which now applies, to *1~Y0,000-$250,000 `of taxable estate would be reduced to 20.8 percent in five years and to 15 percent In ten'years. The second factor of significance is the extent to which exemptions and exclusions plus the marital deduction now provide protection from tax as regards* the smaller amounts of transfers. As computed from Table IV, which abstracts data from taxable estate returns for 1972, exemptIons and mnrital deductions removed 56 percent of the total estates from the' tax base in estates up to $500,000. flut for estates over $5 million, the same* provision re- moved only 14 percent of the total eStates from the tax base. The third factor is that personal hardship under the existing arrangements would in general be limited to situations in which `transfereed property is ~intended to provide for the old age of the surviving spouse, and the 100 per- cent marital deduction wOuld reSolve this situation. 10. Continued Separate Taccation of Estates and Gifts Propo~als for a unified estate and gift tax rate scale tend to assume an inherent inter-connection `between all lifetime (inter vivos) giving and death time transfers. Yet, there is a vast difference between the act of a person who in the prime of life permaneutly foregoes further use of property by giv- ing it away, and the act of a person in providing by will for the disposition of property come the time when he can make no further use of it. When a person' makes a gift of property, the continuity of ownership is broken and his capital worth is diminished accordingly. By contrast, when property Is sold, the seller's capital worth is diminished only by. the amount of the capital gains tax. `UnlesS subseq1i~nti~ ~giJven a~ay, the property remains in one form or another for inclusion In his estate when finally disposed of by PAGENO="0544" 530 will. Thus, there Is no break in the continuity of ownership before death except for the part of ownership taken away by capital gains taxation. The Council's position, set forth in section four, is that continuity in owner- ship ,of capital in whatever form through life and until disposed of at death provides a connection between tax on lifetime transfers and on the final transfer at death which shouhj be reflected in a credit for the former against the latter. By the same reasoning, there is nothing to connect up between life- time gifts and the transfer of prQperty still owned at death, and thus there is no rationale for connecting up or unifying the taxes paid on the two.3 A proposal of the Johnson administration as it went out of oflice in 1968 was that the top rate of estate tax be reduced from 77 to 65 percent over a ten year period, at the same time moving up the top rate of gift tax from 578/~ to 65 percent. Under this proposal, it would beeOme more expensive to give during lifetime and, after lifetime giving, in many if not most eases death duties would be higher on the remaining estates than under present `law. Unifying unconnected tax events, discouraging lifetime giving and assuring higher transfer taxes in many cases add up to a move In the wrong direction. The public interest `in lightening the tax burden on capital would be best served by continuing the separate taxation of estates and gifts, but with p~,ogre~sivelY lower rates and with provision for payment out of income, as proposed in the Council's program. 11,, Avoi~i~g New or AdditionaZ Taa,ation The estate and gift area has not escaped attention in the continuing dialogue on enlarging tax bases. The most prominent proposal identified with this area has been to tax capital gains unrealized at death. Regardless of bow such a tax would be imposed, it wou~cl be anOther_-in effect a double-tax on the capital `which a person leaves at death. As stated earlier, the Council's view is that the carryover tax problem with respect to property at death is not that unrealized gains have not been taxed, but is that the prol~ertY already has been diminished by a tax on capital to the extent of realized gains. Considering the public interest in conserving and enlarging the capital supply, as well as the ~fact that capital held during life and until death is one and the same thing, a credit against estate taxes of capital gains taxes paid during life is advocated by the Council. The imposition of a new t~x at death on unrealized gains is strongly opposed. Two related proposals for increasing estate and gift taxes are those to impose additional taxation for so-called generation-skipping and with respect to other property which had not been reached by transfer taxes over a period of years. For example, the Johnson Administration recommended that: first, to assure tax with respect to each generation, a substitute tax should be imposed to be paid either by the original transferor or, on election, by the first trans- feree; and, second, as an equalizer in the case of non-relatives, such a sub- stitute tax should be applied when the transferee Is more than 25 years younger than the transferor. Such proposals are based on assumptions with respect to the aim of estate and gift taxation which, as discussed under "Objectives of Estate and Gift Taxation," are not reflected in the legislation history of the taxes. The case against the proposals is that transfers by which income from property' becomes available for use in one generation while the capital Is conserved for passing to the next or a later generation serve both the public interest as regards the nation's stock of capital and the government interest as regards revenue. Such a transfer assures that the capital will remain intact for at least one generation, and over the average time span Involved the government undoubtedly would derive much' more revenue than it would have by consuming the capital in the first instance. From the economic standpoint, it would be a step backwards to impose an additional tax under these circumstances. The Johnson Administration also recommended that employee death benefits under qualified pension plans be included in gross estates. While the marital deduction, if raised to 100 percent, would render such an inclusion meaningless Insofar as the surviving spouse is~ concerned, the fact is that such benefits often $ Unless a gift is made in contemT)latiOfl of dc'nth. in which ~`vent it is now included In the decedent's grOss estate with an ofl~settiflg credit for gift taxif paid. PAGENO="0545" 531 are inten'ded to provide support for children and others as well as the sponse dependent on the transferor. Looking on these transactions as extensions of life-time compensation, there seems no appropriate reason why they should be subjected to estate taxation. Conc'usion Looking back, we may wish that the legislators of a preceding era had dis- played greater economic sophistication than Is reflected in the rates of estate and gift taxes which have held for forty years. Certainly, more moderate rates would have meant more capital formation more good 3obs higher standards of living, less inflation and more government revenue over the Intervening years~ But there is one compliment we can pay to the work of those legislators-they did not embellish their aims~ They gave their objective as simply that of rasing revenue. We commend the same objective to this Committee, but to be accomplished differently. We ask that you recognize the public interest in conserving more capital so that it may generate more income which, among other good pur- poses, would raise more revenue than would come from taxing the capital directly~ DETAILS OF PROPOSAL non TAX PAYMENT Tnusrs a. The testator would direct, or the donor in the case of life-time gifts would make, the necessary arrangements. The executor would hot have the power to create or avoid a trust, or the responsibility for its administration. b. The property placed in the trust would become the total security for pay- ment of the tax attributable thereto. c. Approval of k trust by the IRS would constitute discharge of the tax liability insofar as administration of the estate is concerned, permitting final settlement of the estate and discharge of the executor as quickly or often niore quickly than if tax payment were dependent on liquidation of the prop- erty. d. To qualify for approval by the IRS, a trust would have to offer reasonable prospect of paying out In ten years. Legislative history should make clear the Congressional Intent for liberal application of this rule in order to serve the objective of conserving capital in the public interest. Once qualified, the trust would have two years of grace, that is, complete payment of the tax could be stretched out to twelve years. e The testator could direct the executor in ease the IRS questioned whether there was reasonable prospect of payout in ten years, to use suck other funds in the estate or to liquidate such part of the affected property, as might be necessary to make sufficient prepayment of tax to qualify a trust. f. If the trust neverthelesS failed to pay out in twelve years, the beneficiaries would have the option of paying the remaining tax or, If they did not, the trustee would be required to liquidate so much of the property as would be necessary. g. Should it become necessary, however, to liquidate property In order to pay tax at the end of twelve years, the remaining tax should be adjusted so that it requires no greater liquidation of property as a percentage of the total trusteed property that would have been required to pay a comparable amount of tax as of the date of valuation of the property. h. The trust income would be subject to income taxation before payment of estate or gift tax but, in addition to Interest on the estate tax balance, there should be deductible the income attributable to that part of the property which would have been absorbed by the estate tax except for the trust. i. Because of the importance in the public h~terest of encouraging use of tax payments trusts in place of liquidating property to pay taxes, the top rate of income tax on the trust income should be held to 50 percent. COMMENTS RE REVENUE EFFECTS OF TAX PAYMENT TRUSTS It seems questionable whether provision for tax payment trusts would at any time have adverse effect on the revenue derived from they affected property, for several reasons: 68-872-76----35 PAGENO="0546" 532 a. While many wills might be quickly, changed to make use* of the provision, It would take quite a few years before a substantial volume of actual deathtime transfers would be involved. b. It seems reasonable to assume that revenue from lifetime gifts made be- cause of the provision would more than balance stretchout of revenue from other gifts placed in trusts. Because use of a tax payment trusts would relieve the donor of liability for payment of the gift tax, there undoubtedly would be a tendency to Increase the size of gifts correspondingly. c. The government would receive interest On the outstanding tax balances pay- able through tax payment trusts, and when the trusts were terminated would receive tax on income from property which except for the trusts would have been liquidated; d. Because all trust income (after income tax a~id interest) would be payable against the balance of estate (or gift) tax due with respect to the trusteed property, it seems likely that most trusts would pay out within six or seven years. e. An example of the time required for payout follows: 1. Trusteed property $1, 000, 000 2. Estate (or gift) tax 400, 000 3. Gross annual Income from property 100,000 4. Deductions from gross 64, 000 a. 6 percent on estate tax for. first year_ 24, 000 b. 2/5s of income (relation of estate tax to property) 40, 000 5. Subject to income tax 36,000 6. Income tax (single scale to 50 percept top rate) 13, 030 7. Interest and income tax payments (4a and 6) 37,030 8. Payable against estate tax 62,970 9. TIme for payout (years) 7 Of course, the time required for payout would decline as the rates of tax came down. After ten years of rate reduction, the average time would probably be downto three to four years. TABLE 1.-FEDERAL ESTATE TAX TABLE FOR COMPUTATION OF GROSS ESTATE TAX (A) (B) (C) . (D) , Taxable estate equal to or more than- . Taxable estate less than- ~ Tax on amount In column (A) Rate otitax on excess over amount in column (A) ` .. (percent) ` ` ` $5,000 . 10,000 . 20,000 30,000 40, 000 50,000 60, 000 100, 000 250, 000 500, 000 . 750, 000 1, 000 000 1, 250, 000 1, 500, 000 2, 000, 000 2, 500, 000 ` 3, 000, 000 . 3, 500, 000 4, 000, 000 5, 000, 000 . 6, 000, 000 7, 000, 000 8, 000, 000 10, 000, 000 $5,000 0 10,000 $150 20,000 500 30,000 1,600 40,000 3,000 50, 000 4, 800 60,000 7,000 100, 000 9, 500 250, 000 . 20, 700 500, 000 65, 700 . 750, 000 145, 700 1, 000, 000 233, 200 1, 250, 000 325, 700 1, 500, 000 423, 200 2, 000, 000 528, 200 2, 500, 000 753, 200 3, 000, 000 998,200 3, 500, 000 1, 263, 200 4, 000, 000 1, 543, 200 5, 000, 000 1, 838,200 6, 000, 000 2, 468, 200 7, 000, 000 3, 138, 200 8, 000, 000 3, 838, 200 10, 000, 000 4, 568, 200 6, 088, 200 3 7 11 14 ` . 18 22 25 28 30 , 32 35 ` 37 ` 39 . 42 45 ` 49 53 56 59 63 67 70 73 76 77 . PAGENO="0547" ~c~- ~- ~ ~ ~ ~ n(n(n~ cooum~ -I c~c~ ~ ~ ~PPc ~ -4 ~ C) -4 -I > >c C)CO~J~~ c~ ~ ~QC)C)c~ ~ C)C)C)QC)C) -I 0 C,, 0 C,) C, = 0 rn 0 0 C, -4 0 C,, 0 I- C', -4 -4 rn -4 >C -I C,, 03 eQ -4 0', b ~ 0~ 0 01 0) 00 CO 00000)Q~C~ C0Q~~ ~ PAGENO="0548" TABLE IV.-TAXABLE RETURNS, 1972;. FEDERAL ESTATE TAX Number of Size of total estate returns (1) Total estate (2) -~ Qeductions Taxable estate (7) Estate tax before credit (8) Estate tax after credit (9) Total (3) Charitab'e (4) Marital (5) Exemption (6) Under $60,000 4,468 113,013 419,575 31,351 69,571 268,080 483,709 130,317 115,951 $60,000 under $100,000 30,496 2,471, 516 2, 123, 016 12, 748 73,058 1,829, 760 621, 175 90, 110 83, 438 $100,000 under $500,000 75,880 15,218, 373 9,279,450 223,965 3,075,000 4, 552, 800 6, 811, 595 1,531,672 1, 416,856 ~ $500,000 under $1,000,000 6,468 4,396,361 1,889,628 126,995 914, 298 388,080 2, 71~ 698 808,647 717, 963 $1,000,000 under $2,000,000 2,277 3,096, 677 . 1, 290.212 202, 803 636, 516 136, 620 2,058,204 700, 470 604,722 $2,000,000 under $3,000,000 575 . 1,375, 283 528,791 75, 227 . 258, 231 34, 440 891,868 331, 333 282, 068 $3,000,000 under $5,000,000 341 1,286,268 543, 188 116,731 255, 671 20, 460 813, 252 339, 409 284, 147 $5,000,000 under $10,000,030 183 1,257,632 555,026 159,634 216,995 10,980 715, 184 348,685 290,496 $10,000,000 or more 74 1, 549,~137 898, 892 492,693 226,824 4,440 701,092 439,734 357,608 Total 120,761. 30,764,260 17,527,776 1,442, 146 5, 726, 163 7,245, 660 15, 814,777 4,720, 378 4,153,250 Source: Table 2, Statistics of Income 1972-Estate Tax Returns, U.S. Department of Treasury, Internal Revenue Service. PAGENO="0549" 535 The CHAIRMAN. I know you have been coming to this committee about as long as I have been on the committee. Mr. Mills tells me that you have been coming about as long as he has been on the com- mittee, and that dates you a long way back. Mr. DAVIDSON. Thank you. The CHAIRMAN We appreciate the efforts of the Tax Council in this very technical area. Mr. DAVIDSON. Thank you, Mr. Chairman. The CHAIRMAN. Our next witness is Gerald H. Sherman, Counsel for the Association for Advanced Life Underwriting Mr. Sheritian. STAT~ENT O~' G~RALD IL SHERMAN~ cOuNs:EL, ASSOCIATION POR ADVANCED LIPE TINDEEWBITING (AALU) Mr. SHERMAN. Thank you, Mr. Chairman. I appear as Counsel for the Association for Advanced Life Under- writing, a national association of approximately a thousand members who specialize in one or more fields of advanced life underwriting. Collectively, they are responsible for annual sales of life insurance in excess of $~ billion, mostly in circumstances involving complex factual situations and often dealing with business planning consider- ations. One of the major roles played by life insurance in our modern busi- ness society is the provision of the liquidity necessary to enable busi- nesses to continue to function despite the death of a proprietor, part- ner or major shareholder. In our testimony here today we will seek BOARD OF DIRECTORS OF ~nn TAx Covxcn.1 Bernard H. Little, Chairman, Vice President, The Ohio Brass Co. Charles F. Zodrow, Vice Chairman, Vice President, Roadway Express, Inc. Orval M. Adam, Assistant Vice Presi- dent, Santa Fe Industries, Inc. Joel Barlow, Partner, Covlngton & Burling. Roland M. Bixier, Presidents J-B-T Instruments, Inc. Robert D. Buehler, Director of Gov- ernment Relations, The B. F. Good- rich Co. Wallace J. Clarfield, Vice President, Olin Corp. John C. Davidson, President, The Tax Council. Paul L. Dillingham, Vice President, The Coca-Cola Co. Donald K. Prick, Director of Taxes, U.S. Steel Corp. James R. Haney, General Manager-~- Taxes Inland Steel Co. Robert F. Hannon, Director, Arthur Young & Co. Edmund P. Hennelly, Manager, Gov- ernment Relations Department~ Mobil Oil Corp. Thomas P. Rerester, Manager, Coopers & Lybrand. G. D. McEnroe, Treasurer, Halliburton Co. Johnson McRee, Jr., Partner, Brydon, McRee & Smith. Thomas A. Martin, Director, Division of Taxation Amer. Petroleum insti- tute. William J. Nolan, Jr., Vice President, Amax, Inc. Robert T. Scott, Vice President, John- son & Johnson. Leonard L. Silverstein, Partner, Sil- verstein & Mullens. Jennings P. Smith, Senior Tax Coun- sel, Exxon Corp. Robert F. Sumerwell, Tax Manager, Clark Equipment Co. Wilfred J. Trembiay, Director of Taxes, The Hanna Mining Co. Norman B. Ture, President, Norman B. Pure, Inc. David 0. Williams, Jr., Tax Counsel, Bethlehem Steel Corp. 1 A nonprofit business membership policy organization, incorporated in the District of Columbia on Aug. 4, 1966 and formally organize~l on Jan. 5. 1967. PAGENO="0550" 536 `to put before the Committee a number of ways in which the Internal Revenue Code often operates capriciously by adding to after-death liquidity burdens without adequate supporting rationale. We fur- `ther will suggest means to eliminate or substantially reduce this ~capricious operation. As has been painted out by others, without sufficient liquidity a business may have to be dismantled or sold in its entirety to pay debts, expenses and death taxes. There have been. a series of recom- mendations for amendment of the tax laws for the purpose of assist- ing in the development of that sufficient liquidity. Most of these proposals focus on valuation problems, suggest increases in the cur- rent $60,000 estate tai exemption and proffer approaches to liberal- ize estate tax payment deferral techniques currently to be found in the Revenue Code. We generally endorse the thrust of those pro- posals; however, we intend here to address ourselves to less technical issues which have received public discussion. With regard to most of our recommendations, we are suggesting alleviation of liquidity problems through means other than insur- ance. In a narrow sense, this is directly contrary to the immediate economic interests of the AALIJ membership. In fact, the life insur- ance industry as a whole might transitorily profit if the tax rules respecting transmittal' of business interests at death were made harsher. An obvious source from which to service the needs that arise from that harsher result is life insurance. It is our conviction, how- ever, th:a't adding to the tax burden of businessmen, . particularly small businessmen and small . farmers, will eventually serve to de- crease ther numbers and, thus, will ultimately be ~Ietrimental to the long-term interests of this country. The first problem we will look to concerns insurance proceeds used to fund buy-~ell agreements. The problem of stockholder succession in a small business is fre- quently resolved by shareholdE~r. ;buy-sell agreements, funded with life insurance. However, by the, time the shareholders reach the age where the establiehment ,of such arrangements becomes of vital con- cern to them, they may be uninsurable or insurance may be' availa- ble only at a very high premium. If such a shareholder has an exist- ing i~su*~a~ice' policy, he could transfer it" (for adequate cons'idera- tion) to a fellow shareholder whq would comn'T~ence paying the pre- miums `and, thus, be able to use tlae proceeds to purchase the stock of the insured after his death~ Section 101(a) provides, in general, that the proceeds of life in- surance ,r~ccived. upon the death of an insured are uot considered, taxab'le income `u1U~ss `t~b~ policy was transferr~d for valuable con- sideratiomi. However, ~,in' enacting section 101, Congress recognized that there wexte situations involving the transfer of insurance poli- cies for valuable consideration where taxable income should not arise. Exceptions were provided in the case of transfers of policies to the `insured, to hi's partner,' to a partnership in which be s a part- ner,' or to a. corporation in which `he is a shareholder or officer. Illog- ically, `there' ~s no exemption `fOr. sha'rehoider-to~shareholder trans- fers. We. feel that the omissionS of this kind of transfer for the pur- pose of funding a buy-sell agreement is an oversight which, `should be correcte~L,.'., ` ` ` PAGENO="0551" `537 Our written testimony contai~s a significant corrective approach previously recommendea by the American Bar Associatioh. Turning to the issue of comporate distributtons to cover death taxes and expenses, section 303, if a corporate distribution which ~would normally be deemed to be a dividend is received by a decedent stockholder's estate for the purpose of paying death taxes and ex~ penses, a gross distribution of approximately three times the amount of those expenses would have to be made where the marginal ordi- nary income tax rate applicable is 70 percent. Somewhat lesser mul- tiples of the death taxes and expenses would be required to be dis- tributed at lower marginal rates. However, if that same distribution were treated as a distribution in redemption of stock, there would likely be no tax due and the cash drain on the distributing corporation would be substantially less. In recognition of the special nature of the liquidity needs at death, section 303 permits the latter "tax-free" stock red~mption approach to the extent that the distribution does not exceed the amount of death taxes and estate expenses. Unfortunately, that section is ap- plicable only where the value of the corporate stock is greater than 35 percent of the gross estate or 50 percent of the taxable estate. Such' a test, in addition tO its direct hinge' on the relative si~e of the corporate interest as compared to the estate, tends to isolate situations where `the stock is in a corporation that is closely held ai~d small. However, for reasOns we set forth in our written statement, the percentage `limitations in section 303 in fact perform very poorly as indicators of illiquidity. The most rational approach would be to eliminate all these per- centage tests and' to permit rather broad access to th,e' Ccstock redemp- tion" result. Should there be any concern' about the possible use of the section for publicly held corporations, such concern can be allayed if the benefits of section 303 are specifically not made' available' to coiporate stock traded under an established securities market. It might also be contended that the special benefit of section 803 should, in any event, be available only tO estates of some reasoiiably modest size The simplest and most direct way to attain this result is to preclude the benefits of section 303 to' estates w'ho~è gross values or total death taxes and expenses exceed predetermined figures. The removal of percentage tests would simplify section 303, make it more equitable ann eliminate `the tendency now in many cases to structure a predeath situation which falls within the harrow confineS of section 308 even though such tax structuring may rtçn contrary to the thrust of basic economic considerations. ` Another item:little remarked and often `less understood isthc' mat- `ter' of the family attribution rules that are applicable in. detOrmin- ing constructive ownership of stock in closely held corporations The way in which these rules are applied to given situations can deter- mine whether a corporate distribution is to be taxed as a dividend or IS to be received tax-free. `In at least one situation~the Revenue Serf- ice `is propounding an administrative~"approach ~hi'ch is contrary to the statute and will unfairly exacerbate liquidity problen~s' for many small corporations at the death of the major shareholder. PAGENO="0552" 538 Among the constructive ownership rules is one that states that an individual is to be considered as owning the stock owned directly or indirectly by or for members of the family. However, the family attribution rules may be waived and the divi- dent tax not applied under certain, circumstances. Unfortunately, the Revenue Service has taken the position, unsanctioned by the stat- ute, that estates and trusts holding stocks in closely held family corporations may. not file such waivers. They are effectively pro- hibited by the Service from redeeming stock in family corporations no matter how necessitous the circumstances since redemption distri- butions would be treated as ordinary income dividends. The arbitrary consequences of the Revenue Service's approach can easily be seen in the context of a situation in which the decedent stockholder leaves all of his stock in the family corporation to his wife. All remaining stock is owned by his son. If he leaves the stock outright to his wife, it may not, because of the family attribu- tion rules, be redeemed in the hands of the estate without divident consequences. Alternatively, after the estate distributes the stock to the wife, it may be redeemed in the hands of the wife without negative implica- tions arising from the family attribution rules. Last, if the stock had been left to his wife in trust, divident treat- ment of any redemption in the hands of the trust is virtually as- sured irrespective of whether .the stock has or has not been distrib- uted to the trust. There appear to be no viable reasons to support these distinctions. In order to focus sharply on the problems we have been discussing, our written statement concludes with a special illustration setting forth a not untypical situation involving the death of a major share- holder in a series of small corporations. The illustration addresses not only these problems, but also demonstrates difficulties with appli- cation of the ten-year estate tax deferral technique of Section 6166. The kinds of unfair distinctions which are illustrated should not be permitted to continue to occur. Thank you, for the opportunity of presenting this testimony. [The prepared statement follows:] STATEMENT OF GERALD 11. SHERMAN, ASSOCIATION FOR ADVANCED LIFE UNDERWRITING SUMMARY A. Transfer8 of Life Insurance.-Present Internal Revenue Code provisions which allow the transfer of existing Insurance policies for valuable considera- tion without the imposition of income tax on the proceeds when received by a beneficiary should be broadened to include transfers between shareholders In closley held corporations. B. Stock Redem~ptione Under Code Section 303.-Section 308 of the. Internal Revenue Code should be amended to make it applicable in a more equitable way to estates holding stock In no-public corporations. C. Stock OwnersMp 4ttrlbutlon Rule~.-Redemptions of stock without ordi- nary income dividend consequences by shareholders of closely held corporations are strictly circumscribed by statute. Action is urged to clarify the intent of Congress with respect to the filing of waivers of the family attribution rules under Code Section 302(C) in view of the position of the Internal Revenue Service on these matters. STATEMENT My name is Gerald II. Sherman. I am a member of the Washington D.C. law firm of Silverstein and Mullens and am counsel to the Association for Advanced PAGENO="0553" 539 Life Thiderwriting (AALtJ). AALt Is a t~ationa1 assodatfon of approzlitlatei~ a thoti~and members ~rlio spec~a1i2~e In one or more fields of advaileed life under~ writing. Colleetively, they are responsible ~or annual sales ot life 1n~urance in excess of $2 billion, niosty in drcurnstances involving óomplex ~actna1 a1tua~ tions and often dealing with business planning considerations AAL1J Is aIM! ated with the National Asso~iation of Life Tjnderwriters (NALTJ) the largest life h~isnrance industry field force organlzatloti In the United States. NALTJ has a membership of approxhnatêly 130,000 lIfe insurance agents. One of the major rules played by life insurance in our modern business socie- ty is the provision of the liquidity necessary to enable businesses to continue to function despite the death of a proprietor, partner or major shareholder. A good portion of that liquidity need arise from the substantial ta~ obligation that can arise at or soon after de~th. In Our testimony here today, we seek to put before the Committee a nuthber of ways In which the Internal Revenue Code often operates capriciously by adding to or even by alleviating after-death liquidity burdens without adequate supporting rationale and without an equi- table basis which is soundly premised on social or economic need. We further will suggest means to eliminate or substantially reduce this capricious opera- tion. As has been pointed out by many spokesmen in and out of government, in the legislative branch and in the Administration, without sufficient liquidity a business (including particularly, but not exclusively, the business of running a family farm) may have to be dismantled in part or sold In its entirety to pay debts, expenses and taxes. There have been. a series of recommendations by the Administration and others for amendment of the tax laws for the pur- pose of assisting in the development of that sufficient liquidity. Most of these proposals focus on valuation problems suggest increases in the current $60 000 estate tax exemption and proffer approaches to liberalize estate tax payment deferral techniques currently to be found In the Revenue Code (e.g., section 6166). We generally applaud and endorse the thrust of those proposals, but see little profit to the Committee In our repeating, with only cumulative effect, the supporting arguments to these recommendations. We alternatively intend here to address ourselves to more specific and less glamorous technical issues which ha~e tended to receive limited public discussion. As we have said, our intention is to cause the Internal Revenue Code to be restructured in such ways that the special need for liquidity in business transition situations at death will be appropriately and equitably recognized and taken into account. With regard to most of our recommendations, we are suggesting alleviation of liquidity problems through means other than insurance, that is, through means which ultimately have the effect of reducing federal tax burdens. In a narrow sense, this is directly contrary to the immediate economic interests of the AALU membership. The life insurance industry as a whole, and the mem- bers of our organization specifically, might transitorily profit in a selfish way if the tax rules respecting transmittal of business interests at death werO made harsher. An obvious source from which to service the needs that arise from that harsher result is life insurance It is our conviction, however that adding to the tax burdens of businessmen, particularly small businessmen and ~mall farmers, will eventually serve to decrease their numbers and, thus, would ultimately be detrimental to the lông-term interests of this country. Our testi- mony today is premised in this conviction. A. Insurance Proceeds Used To Fund Buy-Sell Agreements-Transfer For Value Problems (!vjv) In a small business organized In corporate form there are not Infrequently two or more unrelated shareholder-employees for whom the business provides the principal source of livelihood. As the business matures and the sharehold- ei-s grow older~ it becomes necessary to plan for the contingency of a share- holder's death. If the wives of the shareholders have not been active partici- pants in the business, the shareholders may be unwilling to have stock owner- ship (with its attendant voting rights) and a proportionate share of the profits go to a non employee Or even If this is not unacceptable the surviving spouse of a sharobolder may have substantial cash needs upon death which can only be satisfied from a disposition of the decedent's Interest In the business T~pX cally, the market for such an Interest i~ limited to the remaining shareholders who may not themselves have the cash necessary to purchase a fellow share- holder's interest. PAGENO="0554" 540 This problem is frequently resolved by shareholder buy-sell agreements funded with life insurance., Unfortunately, however, by the time the shareholders reach the age where the establishment of such arrangements becomes of vital concern to them, they may be uninsurable, or because of age or health pro- blems, insurance may be available only at a very high premium. If such a share- holder has an existing insurance policy or policies, he might wish to transfer them (for adequate consideration) to a fellow shareholder who would com- mence paying the premiums and, thus, be able to use the proceeds to purchase the stock of the insured from his estate. Section 101(a) provides that the proceeds of life insurance received upon the death of an insured are not considerable taxable income to the recipient unless the policy was transferred for valuable consideration. In such case, the insur- ance proceeds in excess of the sum of the consideration paid for the policy a~id the premiums paid subsequent to transfer, are taxable income to the recip- ient. The purpose of the "transfer for value" rule has been stated as one of preventing speculation on the death of the insured.t In enacting. sectior~ 101, Congress recognized that there were situations involv- ing the transfer of insurance pollc~es for valuable consideration where it need not be concerned with such speculation. Exceptions were provided in the case of tri~nsfers of policies to the insured, to his partner, to a partnership in which he is a partner, or to a corporation in which be is a shareholder or officer. These transfers have been recognized as being made for "legitimate business reasons." In establishing these exceptions, the legislature omitted any provision exempt- big shareholder-to-shareholder transfers. We feel that the omission of share- holder~to-shareholder transfers from the excepted categories for the purpose of funding a buy-sell agreement is an oversight which would aid the orderly con- tinuation and continuity of ownership of small, closely held corporations if remedied. It should not be difficult to set up a few simple criteria which would prevent abuses in circumstances where there was no legitimate business purpose. A suggested approach to curative legislation may be found in I-I.R. 11450, intro- duced in the 8Dth Congress by former Chairman Mills at the request of the American Bar Association.' B. Corporate Distributions To Cover Death Tawes and Ea'pen8e8 (~3O3) As a general proposition under the Internal Revenue Code, if a stockholder is in receipt, with respect to his stock, of a distribution from a corporation, that distribution will be treated as a dividend in his hands or as an amount realized on the sale of stock, depending upon certain general applicable standards-some objective, some subjective. The distribution which is deemed to be a dividend Is normally taxed at ordinary income rates that can, of course, reach 70 percent. The distribution which is deemed to be in exchange for redemption of stock is not only taxed as lower raled capital gain but Is subject to tax only on its gain element, if any, after credit is given for cost or basis of the stock. If, under these tests, a distribution which would normally be deemed to be a dividend is received by a decedent stockholder's estate for the purposes of paying death taxes and expe~ises, a gross distribution of approximately three times the amount of those expenses would have to be made where the marginal ordinary income tax applicable Is 70 percent. Somewhat lesser multiples of the death takes and expenses would be required to be distributed at lower marginal rates. However, if that same distribution were treated as a distribution in redemption of stock, there would likely be no tax due (primarily because of the applicability of the date, of death basis rules) and the cash drain on the distributing corporation would be substantially less, In recognition of the special nature of the liquidity needs at death, section 803 of the Revenue Code permits the "tax free" stock redemption approach even S. Rept. No. 1622, 83rd Cong., 2d Sess., p. 14. $~R. 11450 contains the recommendations of the 4~mer1can Bar Association for a wide variety of changes in the Internal Revenue Code. Section 3 of that Bill would also exlend the exception from the transfer for value rule to spouses, former spouses, parents, lineal descendants and adopted children. The explanation of R.R. 11450 published by the ABA concludes that these persons, as well as shareholders of closely held corporations, have an Insurable interest in the life of an insured and thus, could initially purchase from an insurance company a policy covering the insured and receive the proceeds without un- desirable income tax consequences. PAGENO="0555" 541 though the d~stributjo~. would, under general rules, be treated as a dividend. However, such permisSIon is available ouly ~o tb~ extent that the distribution does not exceed the amount of death ~a~es and estate expenses. Unfortunately, ftt the attemj~,t to hew to a standard which wOuld presutha~ly limit the applica- tion of section 808 td situations in which liquidity ear' realistically be expected to constitute a dimeult problem for an ~Ostatë, that section Is made applicable only where the value of the, corporate stock Is greater than 35 percent of the g~oss estate or 50 percent of the taxable estate, Such' a test, In addition to its direct hinge on the relative size of the corporate intere~t as compared to the estate, tends to isolate situations where the stock is bi a, corporation that is closely held and small. However, the percentage limitations In section 808 In fact perform very poorly as indicators of Illiquidity, The fact that a business is small or clos'~ly held is not per se an indication that it lacks liquidlity, furthermore, many estates, the assets of which consist substantially of steck in one or tWo corporations, have ready and full access to cash because those corporate bnslnesses l~ave such access or beca,use other estate assets offer liquidity. Alternatively, estates whose asset mix falls the te'~ts of sectIon 308 can be severely pr~sse4 for cash. Those estates can be committed to corporate and ilon-corporate as~ets (e.g~, non-salable real estate) that have virtually no potentiality for conversion to liquid form. In effect, the basic structure of section 303 asks the wrong prime question and fails to ask other questions which are, of necessity, pertinent. If we attempted to construct provisions which focused ~h'arply on questions of liquidity and, perhaps, of relationship to ~mall' business; we would doubtless have statutory provisions that entail complexity far beyond the social and economic utility `to be attained. It seems to us, therefore, that the most rational approach would be to eliminate all these percentage tests and to permit rather broad access to the "stock redemption" approach. Unsupportable distinctions can, thus, be eliminated. Section 303 in such a revised form will doubtless be used only by small cor- porate businesses since the availability of such a stock red~mptlo~ Is, In practi- cal terms, restricted to such small corporations which can make redemption decisions on a stockholder-by-stockholder basis. It Is' only estates with stock in such corporations that will tend to utilize section 303. There ~hould be little concern that publicly held corporations will adopt programs of making redemp- tions available to stockholders because the stockholder In such a corporation can attain that capital gain result directly by the simple expedient of selling his stock on the open market. If there is any residual concern about the position of publiCly held corpora- tions, such concern ean he `allayed If `the benefits of section 803 are specifically not made' ~vall'ablO to eorporate stock which Is traded on an established securi- ties market. Such a test Is t~tlllzed In the Internal Revenue Code in sections 453(b) (3) and 1282(b) (2) and, perhaps, elsewhere with~~'the Code. A most serviceable definition of "established securities marltet" can be found In Begs. ~1.453-8(d) (4). It might also be contended that the special benefits of section 303 should, In any event, be available only to estates of some reasonably modest size. The simplest and most direct way to attain this result Is to preclude the benefits of section 303 to estates whose gross values or total `death taxes and expenses exceed predetermined fig~res. This limit'atió~ could also be coupled with' a stepped reduction I~i `the availability of the seCtion so that as the size of the estate increases there is a co-relative reduction In the extent to which section 803 may be utilized. The approach suggested here shackles us with neither the false correlation between lack of liquidity and the current percenta~e tests' of section 303, nor with the non-utilitarian complexities of pages of finely spu~n standards which attempt to draw a more precise relationship be4~*een lhp±Edity and quallfieation for application of `this sOetlon. ~`urthermore, the removal of percentage tests would eliminate the tendency now In many cases to st~uctnre a pre-death sitila- tion which falls within the~narro~ copfines of section 303 even though such tax structuring may run contrary to' the thrust of basic economleconsideratious, We commend to you the revision of section 808 In the manner as here suggested. ` ` ` PAGENO="0556" 542 U. Application Oj' Family Sitocic Ownership Attribution Rutes (~3J8) An Lt'em 11tt~e retnarked and often less understood is the matter of the family attribution rules that are applicable in determining constructive ownership of ~stock in closely held corporations. The ways in which these rules are applied to ~given situations can be of extreme importance. Unfortunately, in at least one situation the Internal Revenue Service is currently propounding an administra- `tive approach which, in our view, is contrary to the statute and will uhf'airly exacerbate liquidity problems for many small corporations. Absent the exception provided by section 303 in the closely defined circum- stances mentioned earlier, the redemption of stock in closely held or "family" corporations Is subject to characterization as a dividend rather than as a sale of stock ubless there is full compliance with the rules set out in section 302. These rules are complicated and `subject to being `misunderstood by small busi- nessmen not sophistic~tt'ed in tax law. Section 302 provides that a redemption shall not be treated as a dividend if it is substantially disproportionate with respect to the shareholder redeeming the stock, or if it results in a complete redemption of `all the `stock of the corporation owned by `the shareholder. The constructive owbership rules of section 318, however, state that an Indi- vidual is `to be considered as owning the stock owned directly or indirectly by or for members of his family, and by partnerships, estates, trusts and corpora- tions in which he has an interest. Correct interpretation of these `stock owner- ship attribution rules is difficult, but redemption of stock in a closely held cor- porati6n is to be avoIded. This is because stock legally or beneficially owned by other persons or entities may be deemed under these rules `to belong to the individual disposing of his stock and, thus, prevent the shareholder from achiev- ing a substantially disproportionate redemption or a complete termination of interest In the corporation. Provision has `been made iii section 302 for a waiver of `the family attribution rules provided that: (1) immediately after the re- demption the former shareholder has no interest In the corporation (including an interest as officer, director or employee) other than as a creditor; (2) the shareholder does not acquire any such interest, Other th'an by inheritance, with- in ten years; and (3) proper notification Is made to: the Revenue $ervice by such shareholder.. While the rules regarding stock redemptions in closely held corporations con- stItute a heavy burden for small businessmen doing business hi `this form, we agree `that objective standards in this area h'ave merit because they prevent abuses. We feel, however, that changes should be brought about in the extremely rigid interpretation of the attribution rules by the Internal Revenue Service, particularly with regard to the waiver of the application of these rules provided for in section 302(e) of the Code. The Service has tak~n the position, unsanc- tioned by the statute, `that estates and trus'ts holding stock in closely held family corporation's may not file waivers of the family attribution rules pro- vided by section 302(c).' Accordingly, estates and family `trusts are effectively prohibited by the Revenue service from redeeming stock in family corporations no matter how necessitous the circumstances sihce such redemptions would be treated as an ordinary income dividend.5 The arbitrary consequences of the Revenue Service's approach can easily be seen in the context of a situation in which `the decedent stockholder leaves all of `his stock in the family corporation to hi's wife. AU remaining stock iS owned by his son. If he `leaves the stock outright to his wife, it may not, because of the family attribution rules, be redeemed in the hands of the estate without dividend consequences. Alternatively, after th'e estate distributes `the stock to the wife, it may he redeemed in the hands of `the' wife without negativ'e implica- tions arising from the family attribution rules. Lastly, if the stock had been left to his wife in `trust, divid~nd treatment o'f any redemption In `the hands of the trust is virtually assured irrespective of whether the stock has or has not `Rev. Rul. 59-233, 1959-2 C.B. 1O6~ ~ One tavpayer has successfully challenged In the Tax Court the Revenue Service's contention that an estate cannot file a waiver of the family attribution rules. LUiian M. Crawford v. Conim4~sfoner, 55 T.C. 830 (1973)~ The case may be subject to being dis- tinguished on its facts, however, and there is no indication that the Revenue Service will not contInue to litigate the issue. There has been no determination litigation con- cerning a waiver of the family attribution rules by a trust. PAGENO="0557" 4543 been distributed to the trust. There appear to be no viable reasons to support these distinctions. We urge that corrective action be taken so that all three alternatives may be governed by an approach which permits waiver of the fatally attribution rules and, thus, permits each alternative to be taxed in the same non-dividend manner. D. Special IlZustratio~ In order to focus sharply on the problems we have b~eu discussing, this testi- mony concludes with a special illustration setting forth a not untypical situation involving the death of Mr. Able, a major shareholder in a series of small cor- porations. The illustration addresses not only on sections 101, 808 and 318, but also demonstrates difficulties with section 6166 which is ~ilagued by problems similar to those pertinent to section 303. `1~he kinds of ur~fair distinctions illus- trated here should not be p0r'mitted to oonthiue to occur. Mr. Abel died on June 80, 19Th. At his death, he owned 86 percent of the outstanding stock of King Machine Co. and approximately 29 percent of the outstanding capital stock of Queen Machine Co. He was active in the manage- ment of both compahies. The value of his stock in King w~s $180,000 and the value of his stock in Queen was $100,000. John Abel, Mr, AJ~el's son, own~ed $165,000 in value of King stock and Mr. Baker, an unrelated person, owned the rerhaining $155,000 in value of King stock and the remaining $250,000 in value of Queen stock. There were no other shareholders in either corporation. Mr. Baker, like Mr. Abel, was active in the management, of both corporations. The remainder of Mr. Abel's estate at hi~ death consisted of $35,000 in cash, marketable securities and other liquid assets and $600,000 in value of real estate. `I'hat real estate was purchased at a relatively low cost by Mid. Abel in 1968 for long-term investment purposes. It is undeveloped; there is no relationship to the King and Queen businesses and is sianply being held by Mr. Abel in anticipa- tion of long-term growth. Because of current market conditions, there would be substantial difficulty in arranging a prompt sale of the assets. In effect, the real estate is, for all practical purposes, illiquid. Mr. Abel's estate is subject to short term liabilities of $50,000 and can anticipate expenses and state death taxes of $40,000. Mr. Abel's will provides for a marital deductldn trust for the benefit ~f his wife, with the remainder of his eState going to `his èbildren. Federal estate taxes can be computed as approximately $92~,000. Mr. Abel and ~Lr. Baker had ehtered into a written agreement by which, upon Mr. Abel's death, Mr. Baker would purchase Mr. Abel's interest In Queen for its then fair market value. With respect to King, It wa~ understood that on Mr. Abel's death, John Abel would continue to own his shares `and control the company and Mr. Abel's shares would be redeemed by the company for cash. In 1965, `before Mr. Abel and Mr. Baker had ~ntered into their understanding with respect to the disposition of the stock, Mr. Abel had ta1~en out a $100,000 policy on his life. In 1970, when `the parth~s entered into the stockholder agree- ment, Mr. Abel was no longer insurable. Therefore, Mr. Baker purchased the policy ~rom Mr. Abel for its then cash value, $10,000. He has since paid an additional $8,000 in premiums. It is his anticipation to use the insurance prorn ceeds to fund the purchase price, of the Queen stock. The inability of the Internal Revenue Code to operate equitably in all cases respecting smahi businesses will cause the following detrimental tax conse- quences which will substantially impede the partIes' plans for an orderly after- death tra~isfer of Mr. Abel's `stock: 1. A redemption of Mr. Abel's stock in King by that corporation in the amount of the value of the stock, $180,000, will generate a like amount of ordinary dividend income rather than capital gain simply because Mrs. Abel is a bene- ficiary of ~r. Abel's estate through the marital deduction trust. Such a distribu- tion would have qualified for capital gain treatment if ~rs. Abel had owned the stock directly. 2. No part of a redemption of Mr. Abel's King stOck qualifies for capital gain treatment as being referable ~o federa~l estate, taz, state death tax, administra- tive expense and liabilities. ($92,000+$40,0O0+$50,000=~$1S2,Qo0), since the value of neither the King stock nor the Queen stock in Mr. Abel'~ estate is at least as great as $432,500 (50 percent of the net estate), nor Is it at least as great as $320,250 (35 percent of the gro~s estate). If Mr. Abel had a greater PAGENO="0558" ~44 value in King or Queen stock and, thus, had beeb a substantially wealthier man, he could have obtained the capital gains benefit. See section 303. & Not having been able to effect a capital gains redemption, Mr. Abel's estate Is also not able to utilize the ten year installment spread-forward in the pay- went of the estate tax obligatieb (otherwise available under section 6166), However, as with respect to conclusion No. 2 above, this deferral of tax would have been available if Mr. Abel owned a greater value in King or Queen and had been a substantially wealthier man. 4. Upon the receipt by Mr. Bker of the $100,000 insurance proceeds, he will have taxable income in the amount of $82,000 ($100,000 minus his total acquisi- tion and premltnn cost of $18,000) and, thus, assuming a 50 percent income tax bracket, will be responsible for income taxes of $41,000 and will have on1y ~59,000 of the proceeds available for the agreed `buy-out. If Mr. Baker had taken out the policy oh Mr. Abel's life directly, i.e., if ~r. Abel had been insur- ~able at the time of the' stockholders' agreement, Mr. Baker would not have been `charged with taxable Income `and the tull $100,000 in proceed's would have been available `for the stock purchase. See section 101 (a). The above example graphically illustrates the kinds of inequitable application of the Revenue' Oode which we urge should be corrected by adoption of the proposals suggested in this s'tateiheflt. Thank you for the opportunity to present our views. The CHAIRMAN. Thank you very much, Mr. Sherman. You have all had the opportunity to testify, have you not? That concludes our direct testimony. Do any of the panelists have any supplemental comments or rebuttal to make? If not, we will proceed with the questioning. Are there any questions? Mr. Conable. Mr. CONAEL1~. I would like to ask Mr. Needham this question. One of the allegations about a revaluation of property at death is that it tends to lock in portfolio investments. Your position of course should predispose you in favor of easy flow of capital and I wonder if you' deem this as serious a problem in, let's say, the liquidity of the stock market. Mr. NEEDHAM. Putting aside the tax consequences of such a pro- posal, because from a tax perspective we might have an entirely different view, the stock exchange has always advocated policies which would be compatible with free market forces. People should make investment decisions based on the marJ~ets for the investment being contemplated rather than being forced into making an invest- ment or business decision primarily because of the tax laws. So that would affect our feeling about the assertion made that stripping up the basis on death tends to lock in capital. Mr. C0NABLE. The tax considerations in your view with `respect to many of the proposals that are made for overcotning this would be more detriniental than any possible advantage, is that correct? The taxing of capital gains at death could have the effect of freeing up capital. Do you feel that the tax consequences of that might be rather more negative than any possible advantage to be derived from It? Mr. NEEDHAM. Mr. Conable, what would concern `me with that proposition is that it is a matter of fairness, and also recognizing that any increase in value at death is included in the value of the estate for estate tax purposes. It would have to be worked out on some basis so that people who have done extensive tax planning would be able to make adjustments that were necessary. But on the funda- PAGENO="0559" 545 mental question, if the tax climate were correct, .only' talking noi~" abQ1ut stocks' which are easily transferrable, these of publicly held corporations, I think that we would be in favor of allowing market forces to determine whether s~o~k should be exchanged. Mr. ,00NABLE. Thank you. The CHAIRMAN. Are there further questions? Mr. Pike. Mr. PIKE. I have just one question, Mr. Chairman. Mr. Needham,, I believe that there was a conflict between your testimony and Mr. Reese's testimony as to the cost to the Treasury of the $200,000 exemption. Am I correct in that, and is there any reconciliation between those figures? Mr. NEEDHAM. Mr. Pike, if you will allow me just a moment fo make a reference ~o mine and perhaps hastily consult' with Mr. Reese. Mr. PIKE. I believe Mr. Reese, used figures of a $3.4 billion cost to the Treasury. Mr. NEEDHAM. We use a revenue loss of $2.1 billion based on 1974 values. Mr. PIKE. There is a discrepancy of $1.3 billion. That seems sOme- what substantial. Mr. NEEDHAM. Yes. We will be glad to check and try to reconcile it with the Reese, Mr. Pike. `Our source is also indicated there. The information we presented is from the Congressional Record based on a document from the Economic Division of the Library of Con- gress. I am not quite sure what Mr. Reese's source is. If you l~~e~we can attempt to reconcile it, Mr. Rii~sii. I will be happy to submit something for the record. [The information follows:] rncre'asing the estate Lax exemption to $200,000 will result in a revenue loss of $2.2 bIlUai in fiscal year 1977 and a loss of $3.4 billion when the chang, becomes fully effective Thus Mr Needham s and my figures diffor bee inse ins estimate wa~ for' 1977 while mine gives the cost of the e~emptIon when it `Is fully effective. The source of my estimates is page 8G of `~Data and Materials for the Fiscal Year 1977 Finance Committee Report Under the Congressional Budget Act" prepared by the st'aff for use of the Qommittee on Finance (U.S. Goveri~ment Printing Omce, February 23, 197G). Mr. BURLESON. Would the gentleman yield. Mr. PIKL I will be happy to yield. Mr. Bulu.ES0N. If I understand, Mr. Needham, you feel from your estimates that there will be a gain, actually, to the Government's tax taking by increasing~ the exemption and other allowances ~in the' overall issue. Whereas Mr. Reese would charge off the whole pro- posal as a loss. He fOllows the philosophy of the need for a redis- tribution of the wealth of this Nation, that wealth should not be re- tained in the possession or benefit of those who produce it. Is that a correct st~tement? Mr. NEEDHAM. I think the~re is a difference in philosophy here, and I think terminology or semantics becomes extremely significant I don't view any longer the estate tax as a, means of transferring wealth at all. What it is really is the taxing of wealth and then the' redistribution of it as an income and there is a big difference between PAGENO="0560" 546 wealth and income. I think the point made by the other witness that you are referring to is that were that money reinvested as wealth it would create the type of climate which we believe is compatible with the direction of the economic policy, that is, an expanded gross na- tional product and expanded job opportunities of people. I have had this problem before before this committee in trying to persuade the committee that in the short run the revenue loss to the Government serves the Government's revenue position far better. I wish Mr. Fisher were here. We argued, we thought persuasively, for the abolition of the withholding tax on dividends and interest re- ceived by foreign investors. There is that difference. Some of us take a long-range viewpoint on what is good for this country and others are more concerned with the immediate problems of balancing budgets, and so forth. We understand that those are two positions which are not totally irreconcilable. If you really mean what you say, that you want to transfer wealth, then it seems to me that the Government has to find a way of taking that wealth and perhaps investing it in one of the energy programs that we read so much about. Mr. BURLESON. I thank my colleague for yielding. Mrs. KEYS. Mr. Chairman. The CHAIRMAN. Mrs. Keys. Mrs. KEYS. I had one question I would like to ask of Mr. Reese and perhaps Mr. Davidson, and anyone else who would care to comment. My interest in this* legislation is clearly in doing something about the present situation which really penalizes families for keeping and operating their small farms and small businesses and really rewards them for selling them. In that light, I am quite interested in the testi- mony which I have read but not heard from the two Senators about the estate tax credit as opposed to the exemption and, even though I know, Mr. Reese, that you don't favor the exemption at all, I would like your comments on it, and those of Mr. Davidson or anyone else who would like to comment on that as a lower revenue loser, but something that would certainly enable small farms and businesses to perpetuate the business. * Mr. REESE. I would certainly agree that credit is a much better route to take than exemption. However, in addition, I would like to point out that one of the real problems that the farmers and small businessmen are confronted with was pointed out by Senator Haskell this morning. Current law allows a closely held farm or company business a 10 year period in order to pay the estate taxes. However, current law also makes the executor responsible for those taxes, if they are not paid. The result is that few executors want to take on that responsibility. I think Congress should change the law and substitute a lien on the illiquid assets, the farm or other property for the bond and executor's personal liability. I think that would be~ a very good reform. I think it would help small businesses and farmers. I think we have to worry about anything more than that, ) think the fundamental point we have to remember about the estate taxes is that they are only paid by 6 percent of the people who die so that what we are talking about here is tax relief for the wealthiest 6 per- PAGENO="0561" 547 cent of the people in this country. Last week the Ways and Means Committee was very concerned about the possibility of raising Social Security taxes, which hit the low income people. I think that taking up the question of tax relief for the wealthiest 6 percent of the people in this country is something the American people would not like to see. Mrs. KEYS. Mr. Needham. Mr. NEEDHA1~L. I would like to point out that the 6 percent of the people, the wealthy people, are dead. Mr. REESE. Then they won't paying taxes. Mr. GIBBONS. I hope they don't say that about you when you die. Mr. REESE. I don't think I will have that kind of estate. Mr. DAVIDSON. Ms. Keys, the point of Senator Beall's testimony that I was interested in is th.e valuation based on present usage. I happen to have a lot of farmers in my family on my wife's side. It seems to me that if you did permit valuation based on present usage you would probably be taking the major step toward the preserva- tion of the American farm in terms of the family who owns it. Generally it is better to reduce the rates than increase exemptions. It is not because we want to tax anybody. Quite to the contrary, we would like to see the estate and gift tax gotten rid of. By its very nature it is a very narrowly based class tax and if you increase the exemptions you further narrow the base. We think it would be better to keep a broader base with lower iates. We don't support any spe- cific level of exemption and don't oppose an increase but think a rate reduction is a proper route. Mr. ZISSMAN. May T add a word. If the purpose of the committee is to encourage greater use of section 6166 by executors of estates to bring about the retention of closely held businesses and farms, I urge that you not lose sight of the fact that the current ~ percent interest rate under that section serves as a disincentiveS to the use of that section. I would urge con- sideration of a lowering of that rate, and one of the rates suggested has been 4 percent. Mrs. I~EYS. Thank you. The CHAIRMAN~ Mr. Archer. Mr. ARCHER. Along the lines of immediate revenue considerations and long term revenue considerations, would any of you gentlemen have comments upon the possibility of lowering the maximum tax rate from 70 percent to 50 percent, and what the revenue impact would be, particularly in the long term? We know that the estimates are about $100 million a year on the short term basis, but do you feel that in the long term~we might pick up more revenue by the abandonment of various foundation and trust gimmicks which are set up today in order to escape the 70 per- cent rate. Mr MCRflE T would like to say this In any event the best thmg to do with the e~tate tax is to lower the rates right down the fine because that gets at the heart of the problem and, as you pointed out, makes these gimmicks somewhat unnecessary. Really, the most im- portant factor is the estate tax itself would, it sesms to me, be the lowering of the rates, or perhaps the elimination of the tax. PAGENO="0562" 548 In the long run, the benefits of the additional capital formation, of is going to be far, far in excess of any revenue loss that you would have by lowering the rates. Mr. AncireR. Would anyone else like to comment? Mr. DAVIDSON. We recommend a reduction of the rates in our pro- gram offer a 10-year period which would bring the top rate down to 38 percent instead of 50 percent, and there is an estimate in our statement that at the end of the 10-year period the Government would be losing $10 billion in estate tax revenue, but actually would be getting $8 billion back in income and excise tax revenue and in the 12th year would be breaking even, and after that it would be all gravy. Mr. ARciren. So that in the long term the Government would be better off revenue-wise by reducing the top bracket rate. Mr. REEsE. If I may comment, Mr. Archer, there seems to be a lot of worry about the effects of estate taxes on capital formation. I think the real question is who is going to control the capital with which we are going to form our economy. If the people in these very high brackets ,of wealth don't pay taxes on that wealth, then the revenue will have to come from people in the lower brackets, the middle income people, and their taxes will go up. They won't be able to have money to buy stock, to invest, to even have money in the bank. The question is who is going to have the money to do the capital formation. If we increase Social Security taxes, if we increase income taxes to make up for the revenue loss from any type of estate and gift tax reductions then we are just increasing the distortion in our society of very wealthy peopi.e being in control of all the capital. Mr. ARCHER. You get into a basic philosophical argument, and I did not intend to get into that, but since you brought it up you must get into the question of the private ownership of property, whether the Government should have the power to confiscate the earnings of a citizen, whether you have private ownership o:f property, this gets to the question of tax expenditures which we hear so much about, that if you don't tax somebody you are spending money out of the Treas- my, which is predicated on the fundamental philosophy that the Federal Government has a preemptive right to every dollar earned by an American, and it is only through the grace of Government that you get to retain any of it. I personally do not agree with that concept. I did not intend to get into the philosophical end of it but certainly you have to make a decision fundamentally whether you believe in a free private enter- prise system, with private ownership of property, where a person who is willing to put out the effQrt to accumulate capital and then re- invest it to create jobs, whether that is the type of society we want, or whether we want the Government redistributing and making these deeisions. That is a fundamental decision that we have to make. I believe, particularly after examining Russia and what is happen- in~ in England and some of the other countries of the world that believe that the government should make these decisions, that we have by far the best system that benefits the greatest number of people, but that is a fundamental decision that we have to make. PAGENO="0563" 549 It seems to me that we~ shotild come down on the side of the type of system that we have in this country. rI~hank you for giving ~ne an opportunity to express my philosophi- cal views on that. But the impact of our deliberations on estate taxes ultimately is the question of capital formation and whether we are going to `have the necessary amount of capital to create the jobs, and that is something that I think the committee has to considei Mr. R~sE. I agree with you, Mr. Archer, and I support the free enterprise system. I am not a socialist. My simple feeling is that we are faced here with a question of who is going to pay taxes. As long as there are Government expenditures somebody has to pay. I think the wealthy should pay their fair share. Mr. ARCHER. Don~t you agree that once the Government takes over 50 percent of an individual's property or income, that the Govern- ment has t~ie primary equitable ownership in whatever that indi- vidual does? I know former Chairman Mills has said many, many times that a government should not take over 50 percent because it then becomes the dominant equitable owner in whatever transaction is going on. We have a philosophical question there as i~L relates to the private ownership of property. Does the Government have the right to take over 50 percent of what a person has, or what a person earns? It is the high escalating tax rate that brings about tax shelters and a lot of the problems in trusts and foundations and other things relating to efforts to escape the estate tax. rfliank you, Mr. Chairman. rfhe CHAIRMAN, The. Chair will announce that at a quarter to 1~ we will take up another niatter. Are there any further questions? Mr. Corman. Mr CORMAN I will just take 1 minute and then yield to Mr Thm can. I just want to suggest that taxation and socialism are not neces- sarily synonymous and, as* a matter of fact, I guess if you had pure socialism you wouldn't need taxation. * The difference I have with my good friend from Texas, and I respect his philosophy, is that what it seems to me we owe to the taxpayers is equity among them, and to say to some, "We are going to take a rather substantial percentage; of your income", but to others, "We are not", when they each have the same amount of in- comes seeiñs to me to be the point at which we are not fair. I have used my minute-but I wanted to make a case for free enter- prise and taxation being consistent with each other. The CHAIRMAN. Mr. Duncan. Mr. DUNCAN. I have just one question, Mr; Chairman. Could one of you gentlemen tell -us whatpereentage. of estates gen- ei ate estate taxes ~ Witat percentage are we talking about ~ Mr. EEESE. Six percent of the poeple who die pay estate taxes. Mr. DUNCAN. Thank you, Mr. Chairman. The QIIAIRMAN. Thank you very much. The panel has been excel- lent. We appreciate your cooperation. [Whereup~ii, at 11 ~45 a.m., the comniittee proceeded t&Other busi- ness and the hearing was recessed, to reconvene at 1:80 p.m.] PAGENO="0564" 550 A~TERNooN SESSIoN The CHAIRMAN. We are very pleased to welcome the members of this panel from the Forest Industries Committee on Timber Valu- ation and Taxation, Bradford S. Weilman, chairman, estate and property taxation committee, and 3. Gordon Powell, forest economist. From the American Forestry Association, Mr. William E. Towell, executive vice president; and the National Limestone Institute, Rich- ard P. Rechter, chairman of the board, and Clark G. McChnton, past chairman and member, executive committee. We are pleased to welcome you before the committee. Mr. Wellman, would you like to start off? A PANEL CONSISTING OP FOREST INDUSTRIES COMMITTEE ON TIMBER VALUATION AND TAXATION, BRADFORD S. WELLMAN, CHAIRMAN, ESTATE AND PROPERTY TAXATION COMMITTEE~ AND J. GORDON POWELL, FOREST ECONOMIST; AMERICAN FOR- ESTRY ASSOCIATION, WILLIAM E. TOWELL, EXECUTIVE VICE PRESIDENT; AND THE NATIONAL LIMESTONE INSTITUTE,. RICHARD P. RECHTER, CHAIRMAN OF THE BOARD, AND CLARK C. MeCLINTON, PAST CHAIRMAN AND MEMBER, EXECUTIVE COMMITTEE Mr. WELLMAN. Thank you, Mr. Chairman. I appreciate the opportunity. I have already submitted written testimony. The CHAIRMAN. Without objection, your full statement and the full statements of all the panel members will appear in full in the record and any supplemental materials. You may proceed to summarize. STATEMENT OF BRADFORD S. WELLMAN Mr. WELLMAN. My name is Bradford S. Wellrnan, of Bangor, Maine. I am the agency and attorney-in-fact for private forest land owners owning collectively nearly one million acres in Maine and New Hampshire. I am also associated with Seven Islands Land Com- pany of Bangor, a professional forest land. management company. Neither my clients nor Seven Islands own any mills or other produc- tion or operating facilities. Receipts are those solely derived from the sale of standing timber-commonly called stumpage. I am the Chairman of a Subcommittee of the Forest Industries Committee on Timber Valuation and Taxation dealing with Federal estate tax matters. In the nation as a whole, close to 00 percent of the total forest re- source is owned in small acreag4es by private individuals; approxi- mately 4.~i million owners. As land prices and development pressures escalate, the estate tax will fall most heavily on these individuals. Individually, their ownerships are small, in ~he aggregate, they ac- count for a major portion of the resource. In 1972, the American Forest Institute surveyed 33,000 individuals; over 29,000 of whom were tree farmers. The survey showed that the PAGENO="0565" 551 present average period of ownership is between 20 and 30 years-not quite long enough to complete a forest rotation. Although for all of us death and t~xes are sure, the problem is especially acute for this asset since the sample indicates that 65 per- cent of the owners of 51 !iercent of the timber production will be in estate tax proceedings withiu 10 to 15 years. This is exactly when the country will be needing wood from their forest lands. U. S. Forest Service figures prpject that within 20 years we will be needing almost double the present production of wood products. Recent trends in reducing harvest from national forests put even more pressure on private lands to meet this country's wood needs. The estate tax will force more and more of these indi- viduals. to take land out of resource production to get immediate in- come for estate tax payments right at a time when we would need their wood. Commercial timberland, that is forest acreage capable of and potentially available for growing merchantable trees, in Mame amounts to 16,894,000 acres, approximately 50 percent of wiuch i.s owned by the paper and forest industries companies. The other half is owned by some 100,000 private individual owners in large and small amounts. These lands produoe a little more than half of the forest products used by the local economy. In the 1930's the values of timberland dropped to a low of 50 cents per acre and neither the private owner nor companies saw any ad- vantages or threat in the estate tax. However, by the late 1960's and early 1970's, prices paid for timber- lands and also fair market value for estate taxation purposes had advanced in some instances to as high as $100 per acre. Th~se~ levels in fact are such that at the low rate of economic return available in the market place for the sale of standing timber~ the private indi- vidual commercial timberland buyer has vanished from the scene. The only private buyers we now see are those whose use of the land for commercial timber purposes is incidental to some other use such as recreation or aesthetics. During this same period Congress reduced the settlement period of the estate from 18 months to 9 months. Upon the death of the landowner the executor has got to make some hard and qui.ck decisions in the face of a limited market. If the land is owned jointly with either another private owner or a paper company-as is often the case in Maine-and the other owner is re- luctant to cut or has differing. objOctives, lengthy court proceedings are often necessary to arrange partition. Even in the case of outright fee ownership Or when joint owners can agree, drastic harvesting may be required. Harvesting a large timber inventory all at once can be bad forestry in that it disrupts seed sources, wildlife, watersheds, and other benefits of the forest. TI also tends to disrupt the local market price situation Liquidation of a large timber source is also generally physically and economically impossible due to limited markets, limited labor, limited transporta tion, et cetera. The executot~s option of a sale of standing timber is, therefoi e, often impractical or causes poor ~orest practices Bankers are generally rehictan~ to loan money using the land for security because of the risk factor from fire and disease-presently PAGENO="0566" 552 Spruce Budworm-and one has to~ be pretty large to borrow from an insurance company. Therefore, the executor i.s almost forced into a sale of all or part of the land to a large company or to a developer-if such are in fact interested or capable of making the purchase at that time. The' President has pointed out this factor in the case of farms, but the problem is even more severe in the case of forests because forests are not an anhual crop but a long term investment. A tree planted in Maine today may not be harvested for anywhere from 40 to 80 years. The current owner may well be inhibited from using present income to improve his forest land and a forest improvement practice passed over is probably lost forever. The resultant concentration of forest lands into the hands of a few corporations may well reduce both the diversity of small to medium satellite wood using industrial activities ~nd the forest itself. The reason for this is that a paper company will tend to develop that uni- form specie's and growth best suited to ~ts basic milling capacity and interest. The private owner tends, on the other hand, to maximize the diver- sity of his fore~t growth and, therefore, to support a r~ultiplicity of markets in order to protect himself from the vagaries, of the econ- omy and the use of forest products. He tends to place his eggs in as many baskets as possible. Development of the forest or farm removes the area, generally irre~ trievably, from resource production. Now, unless you think I am making something up let me read to you from `a letter handed me by an executor; Since the tax was there and had to be `paid by law we were forunate in having a buyer at that particular time although from the standpoint of the estate, the situation required liquidation of a considerable portion of the estate and the turning over of the property to a large paper company-I would say the Government's approach in this situation causes property to be sold and the principal customers tend to be paper companies. Now I have a few proposals that we have considered and would like to suggest to you for your consideration in your deliberation on these matters. We believe the present estate tax rates are too high~ Growing competition for capital requires timber growers be given every incentive to invest in sound forestry practices: High estate' taxes have the reverse effect because they discourage such investment. In particular, we urge that if proposals for changing the treatment of appreciation at death are adopted, a corresponding reduction be made in the estate `tax rates. We urge that such reduction exceed any revenues from such proposals in order to compensate for the admin~ istrative hardships and liquidity problems that would be created. INCREASE THE PRESENT EXEMPTION FROM ESTATE TAXES In addition to reducing the estate tax rates, the $60,000 exemption from the estate tax should be amended. The exemption is clearly out of date and no longer serves the purpose for which it was enacted. Accordingly, we urge that the exemption be increased to $200,000 to make it conform to the current economy. ~We basically endorse the President's proposal to relieve the execu- tor of liability for all postponed taxes on farms and related types PAGENO="0567" 553 of assets. As indicated above, we would urge that timberlands be in- cluded as an item subject to this treatment. Going beyond that, how- ever, we should point out that timberland, unlike farms, does not necessarily have an annual income and, therefore, additional special rules are appropriate. We recommend that estate taxes on all `land used for the com~ mercial production of trees, which was owned by th~ decedent at least 5 years prior to his d~cease, should., ,at the option of' the execu- tor, be payable at the earlier of eithet ~Of two occurrences: 25 years from the date of death, or an economic event, such as the `sale and cutting of timber or the sale of the timberland. We think it proper that a lien should attach to the land until the tax is paid, and indeed~ should run with the land as a debt upon the asset in case the surviving heirs should in turn decease prior to the passage of 25 years or the economic event. In other words, the tax obligation would be treated exactly as a mortgage for the purpose of valuation in the hands of the executor of the second estate. The interest rate on these deferred taxes should be below current interest rates to reflect the low earning power of the timber growing stock. In addition to &e liquidity problem, one of the major problems faced by administrator -of estates containing small businesses, farms~, -and timberlands is the -problem of ascertaining the fair market value. A number of proposals have been introduced oyer the last few years to provide more specific rules for valuing such assets. These proposals providing for current use valuations are supported. These proposals alleviate the problem caused by high valuations placed on timber property because the property has a higher value if used for purposes other than growing timber. These valuations proposals should not be viewed as substitutes for liberalization of the estate tax payment rules as described above. They are necessary in addition. The above Forest Industries Committee on Timber Valuation and Taxation proposals would achieve greater equity ~within the estate' tax system without changing the existing framework, Th~ United States is at a point in its history where tremendous amounts of capi- tal are necessary in order to expand and compete. Nowhere is this' more true than in long-term timber operations. Every encouragement should be given to individuals to accumulate capital and put it to work in businesses creating new jobs. We feel that the above pro- posals will carry out these objectives. The CHAIRMAN. Th~nk you very much. - Without objection the supplemental materials -will be included in the record. [The prepared stateme~it and supplemental materials follow:] STATEMRNT OF BRADFORD S. WELLMAN, FOREST INDUSTRIES COMMITTEE ON TIMBER VALUATION AND TAXATION My name is Bradford S. Weilman of Bangor, Maine. I am the agent and attorney-in-fact `for private farest land owners owning collectively nearly one million acres in Maine and New Hampshire I am also associated with Seven Islands Land Company of Bangor a professional forest land management company. Neither my clients nor- Seven Islands own any mills or other pro- PAGENO="0568" 554 duetion or Operating facilities. Receipts are those solely derived from the sale of standing timber-commonly called stumpage. I am the chafrnian of a sub-committee of the Forest Industries Committee on Timber Valuation dealing with Federal estate tax matters. Earlier this year our Committee, recognizing both the impact of the Federal estate tax on timberlands and the fact that your Committee intended to commence work on the estate tax, began a nationwide survey in an attempt to develop material for your consideration. Our data is incomplete and ~we would appreciate the opportunity to appear before you again to submit additional material to your Committee at the next opportunity. In the nation as a whole, close to 60% of the total forest resource is owned In small acreages by private individuals; approximately 4% million owners. As land prices and development pressures escalate, the estate tax will fall most heavily on these individuals. Individually, their ownerships are small. In the aggregate, they account for a major portion of the resource. In 1972, the American Forest Institute surveyed 3~l,000 individuals; over 29,000 of whom were tree farmers. The survey showed that the present aver- age period of ownership is between 20 and 80 years-not quite long enough to complete a forest rotation. Twenty-eight percent of these individuals were over 50 years old; 37% were over 60. Although for all of us death and taxes are sure, the problem Is especially acute for this asset since the sample Indicates that 65% of the owners of 51% of the timber production will be in estate tax proceedings within 10 to 15 years. This Is exactly when the country will be needing wood from their forest lands. U.S. Forest Service figures project that within 20 years we will be needing almost double the present production of Wood products. Recent trends In reducing harvest from national forests put even more pressure on private lands to meet this country's wood needs. The estate tax will force more and more of these individuals to take land out of resource production to get immediate income for estate tax payments right at a time when we would need their wood. I would appreciate the opportunity to send more complete data to you at a later date. I know other foresters and organim~tions are equally concerned about the effect of the estate tax on forest land, such as: The Society for the Protection of New Hampshire Forest, Maine Forest Products Council, New Hampshire Timberland Owners Association, Vermont Natural Resources Coun. cii, Connecticut Forest and Park Association, Society Of American Foresters, Forest Farmers Association, and others. Attached is a list of all supporting associations. I am, however, familiar with the estate tax Implications on commercial timberland in Maine and from this perspective would request your indulgence for a few minutes. Commercial timberland, that is forest acreage capable of and potentially available for growing merchantable trees, in Maine amounts to 16,894,000 acres, approximately 50% of which is owned by the pap~r and forest industries companies. The other half is owned by some 100,000 private individual owners in large and small amounts. These lands produce a little more than half of the forest products used by the local economy. Of the privately owned half, approximately half (or a quarter of the whole) is owned by people such as the owner I represent and is under professional management by companies and agents such as Seven Islands. The history of the ownership of Maine's commercial forests goes hack to the mid-l9th century when the land was purchased from the States of Maine and Massachusetts by individual loggers for the pine and spruce markets. These individuals often pooled their efforts and purchased the lands as tenants4n- common. As paper companies such as International Paper and Great North- ern expanded into Maine, about the turn of the century, they commenced an active purchasing program from many of these individuals. Thi~ resulted in an exceedingly complex ownership pattern of private owners and corporate interests over substantial acreage. These acquisitions were done for the legiti~ mate corporate purposes of securing the forest base for their business and as I said earlier, now amount to about half of the total forest acreage in Maine. In the 1930's the values of timberland dropped to a low of 50 cents per acre and neither the private owner nor companies saw any advantage or threat PAGENO="0569" 555 in the estate tax. However, by the late 1960's and early 1970's, prices paid for timberlands and also fair market value for estate taxation purposes had advanced in some Instances to as high as $100.00 per acre. rrhe$e levels in fact are such that at the low xatc of economic return available in the market place f~r the sale of standing timber, the private individual commercial timber- land buyer has vanished from the scene. The only private buyers we now see are those whose use of the land for commercial timber purposes is incidental to some other use such as recreation or aesthetics. During this same period Congress reduced the settlement period of the estate from 18 months to 9 months. What then is the actual result upon the death of one of the owners that I refer to? The usual statement is that there is an estate liquidity problem. Well, that reply is an oversimplification of the problem. Upon the death of the landowner the executor has got to make some hard and quick decisions in *the face of a limited market. If the land is owned jointly with either another private owner or a paper company (as is often the case in Maine), and the other owner Is reluctant to cut or has differing objectives, lengthy court proceedings are often necessary to arrange partition. Bvon in the case of outright fee ownership or when Joint owners can agree, drastic harvesting may be required. Harvesting a large timber inventory all at once can be bad forestry In that It disrupts seed sources, wildlife, water- sheds, and other benefits of the forest. It also tends to disrupt the local mar~ ket price situation. Liquidation of a large timber source is also generally physically and economically impossible due to limited markets, limited labor, limited transportation, etc. The executor's option of a sale of standing timber is, therefore, often impractical or causes poor forest practices. Bankers are generally reluctant to loan money using the land for security because of the risk factor from fire and disease (presently Spruce Budworm) and one has to be pretty large to borrow from an insurance company. Therefore, the executor is almost forced into a sale of all or part of the land to a large company or to a developer-~4f such are in fact interested or capable of making the purchase at that time. The market seems to be limited in any one instance to 2 to 5 proSpective purchasers. Slowly, therefore, over the years I have witnessed the increase of the corporate ownership and tie- velopinent sales and the decrease of long term private own~rship. Now I suppose you can argue that these are the facts of life hut there are three things wrong with this: (1) The estate and the beneficiaries are being forced into a limited market sale causing them to forfeit the value and effort of the prior sound practices of the decedent such as planting, stand Improvement practices, fertilization, etc. The President has pointed out this factor in the case of farms, but the problem is even more severe In the case of forests because forests are not an annual crop but a long term Investment. A tree planted in Maine today may not be harvested for anywhere from 40 to 80 years. The current owner may well be inhibited from using present income to Improve his forest land and a forest Improvement practice passed over Is probably lost forever. (2) The resultant concentration of forest lands Into the hands of a few corporations may well reduce both the diversity of small to medium satellite wood using industrial activities and the forest itself. The reason for this is that a paper company will tend to develop that uniform species anti growth best suited to its basic milling capacity anti interest. The net result will he over a long period of time to restrict the ability of the area to generate a small diversified forest products economy. The private owner tends, on the other band, to maximize the diversity of his forest growth and, therefore, to support a multiplicity of markets in order to protect himself from the vagaries of the economy and the use of forest products. He tends to place his eggs In as many baskets as possible. (3) If, of course, there are sufficient alternative as~ets that readily can he disposed of to pay the taxes, the executor wilt he faced ~tifh the hard choice of selling these more lipild assets and reta1n~pg the land. Executors are wary of this because `they could he subject to attaek for retaining a high risk asset in preference to the higher Income producing items which have been better marketability. Even In the case where the executor has n~thority to retain sn~h assets, he Is leery because he may. In fact, by so doing he working against the best Interest of the beneficiarles~ The result in such cases Is the sale of a part of the land assets-and interestingly enough a retaining of the portisn PAGENO="0570" 556 which the estate beneficiaries have requested on some other basis than `commercial timber use either for aesthetic or persoiiaj recreation or potential ~development. Thus the unsold portion is often withdrawn from all but mci- `dental cutting 9~ trees and is held for other purposes, The fragmentation of the asset invariably leads to the reduction or elimination of intensive forest practices. Estate taxation has the effect of concentrating forest lands in the hands of a few where large acreages arC involved and there are large indus- tries to buy it. In more urbanized areas where the ownerships are small, the tendency is for the land to be sold for development because this is the only way the heirs can generate funds to pay the estate tax. Development of the ~forest or farm removes the area, generally irretrievably, from resource pro- `duction, Now, unless you think I am making something up let me read to you from a letter handed me by an executor; `Since the tax was there and had to be paid by law we were fortunate in having a buyer at that particular time al- though from the standpoint of the estate, the situation required liquidation of a considerable portion of the estate and the turnix~g over of the property to a large paper company-I would say the Government's approach in this ~situation causes property to be sold and the principal customers tend to be paper companies-". Now, I do not fault these companies. They are doing their job well and taking no unfair advantage of anybody. The economics of the situation makes them the best market. PRO?0SALS RECOMMENDED BY TIlE FOREST INDTJSPRIES COMMITTEE ON TIMBER VALUATION AND TAXATION There are a number of specific proposals which are supported' by the Forest Industries Committee on Timber Valuation and Taxation: A. Reduction in Estate Tax Rates The present estate tax rates (top bracket of 77%) are too high. Growing competition for capital requires timber growers be given every incentive to invest in sound forestry practices. High estate taxes have the reverse effect because they discourage such investment. In particular, we urge that if proposals for changing the treatment of ap- .preciation at death are adopted, a corresponding reduction be made in the estate tax rates. We urge that such reduction exceed any revenues from such proposals in order to compensate for the udministrative hardships and liquid- `ity prOblems that would be created, B. Increase the Prescnt Exemption from Estate Taxes In addition to reducing the estate tax rates, the $~l0O,000 exemption from the estate tax should be amended. The exemption is clearly out of date and no longer saves the purpose for which it was enacted. Accordingly, we* urge that the exemption be increaSed to $200,000 to make it conform to the current `economy. Ajternative Estate Tax Rayment Rules We basically* endorse the President's proposal to relieve thq executor `of liability' for all postponed taxes ~on farms and related! types of assets. As ip- `dicated `above,' we would urge that timberlands be included as an item subject to `this `treatment. Going beyond that, however, We should point out that timberland, unlike farms, does not necessarily have an anrimil income and, therefore, additional special rules are appropriate. We recommend that estate taxes on all land used `for the commercial `production of trees', which was owned by the decedent at least five years prior to his decease, should, at the option of the executor, be payable at the earlier of either of two occurrences: twenty-five (25) years from the date of death or an economic `event, such as' the sale and. cutting of timber or `the sale of the timberland, We think it proper that a lien should `attach to the land until the tax is paid and Indeed should run with th'e land as a debt upon the asset in case the surviving heirs should in turn `decease prior `to' the passage of twenty-five (25) years or the `economic event. In other wordS, the tax obligation would be treated exactly as a mortgage for the. purpose of valuation in'. the hands of the executor' of the second estate.' The interest rate on these deferred taxes should `be `below "current Interest rates to reflect the low earning power of the timber growing `stock. PAGENO="0571" Joe W. Graham, Alabama. Forestry As~ sociation, Montgomery, Ala. Donald A. Bell, Alaska Loggers As~o- ciations, Inc., Ketchikan, Alaska. 3. Mason Meyer, American Hardbosrd Association, ~ Ill. Paul R. Beattie, A.meriean Institute of Timber Construction, Engle~OOd, Cob. Edwin A. Locke, Jr., American Paper Institute, NewYork, N.Y. )3ronson 3.. ~Lewis,, American Plywood Association, rEacoma, Wash. K. S. Eolston, Jr., American Pulpwood Assoeiatiou, Wasiiirig~on, D~C. 5. Lundie Smith, American Titrpentlne Farmers Association co-Op, Val- dosta, Ga. John P. Ferry, American Wood Pre~ servers Assn., Washington, t~.C. Theodore J. t~uke, American Wood Preservers Inst., .Mc~ea13, Va. James L. Gundy, Appalachian I4ard- wood Manufacturers, Iiic~ Point, N.C. M. F. Taylor, Arkansas Forestry As- sociation, Little Rock, Ark. Bernice Spilker, Associated Cooperage Industries of America, Inc., St. Louis, 1\~o. Ivan Congletoti, Associated Oregon In~ dstries, Salem, Oreg. Edward Sttiart, Th, Association of Con~u1tthg~ Foresters, Wake, Va. John Callaghan, California FQrest Pro- tective Association, Sacramento, Calif. Paul Barringer, ~1Dastern North Caro- lina Lumber Manufacturers Assn., Tnc., Weldoh, N.C. Nicholas E~Irkmire, Federal Timber Purchasers Assu., Denver, Cob. 1~ona1d H. GOtt, Fine Hardwoods- American Walnut Association, Chi- cago, Ill. William Carroll Lamb, Florida Pores- try AsSociation, Tallahassee, Fla. 5. Walter Myers, Jr., Forest Farmers Associaitofl, Inc., Atlanta, Ga. Harold Joiner, Georgia Forestry As- sociation, Inc., Atlanta, Ga. J. Edgar Kennedy, Eardwood Dimeti- sion Mantifacturers, Nashville, Penn. Clark ~. McDonald, flardwood Ply- wood Manufacturers Association, Arlfti~ton, Va. W. D. iiágenStein, Industrial Forestry Association~ Portland, Oreg. Jàmés, Newnis~ti, TCentucky Forest In- dustrial Association, Lexington, Ky. * William I~:; Matthews, Louisiana ~I3'orestry .~t~sociation, Alexandria, Frañ1~ M. Atéble~T, Lumber Manufac- ttit~ets A~socth~tion of Virginia, Bthi~stoii, Va. Charles M. Washbnrn, Maine Forest Proç~u~ts Council, Bangor, Maine. I~ob1e~ Nash, Maine Hardwood As~o- ciatidn, Au~usta, Maine. M. H. Allen, Minnesota Timber Prod- ucts Association, Duluth, Minn, Glen, Jones, Mississippi Foresti~y As- sociation, Jackson, Miss. 557 D. T7aluatlon of Timber Properties in an Estate In addition to the liquidity problem, one of the major problems faced by admihistrators of estates containing small businesses, farms and timberlands Is the problem of ascertalnitig the fair market value. A number of j~roposals have been introduced over the last few years to provide more specific rules for valuing such assetS. Many of these provide that the value of such property in the gross estate shall be the value of such property in its current use. These proposals providing for current use valuations are supported. These proposals alleviate the problem caused by high valuations placed on timber property because the property has a higher value if used for purposes other thaii growing timber. rfllese valuation proposals should not be ~iëwed as substitutes for liberal- ization of the estate tax payment rules as described above. They are necessary hi addition. CONCLUSION The above Forest Industries Committee on Timber Valuation and taxation proposals would achieve greater equity within the estate tax system without changing the existing framework. The United States is at a point in its his- tory where tremendous amounts of capital are necessary in order to expand and compete. No where is this more trtie than in tong term timber opera- tions. Every encouragement should be given to individuals to accumulate capital and put it to work in businesses creating new jobs. We feel that the shove proposals wilt carry out these objectives. Fonitsu INDUsTntEs CoMi~ITitEg ON TIMSEn VALUATION AND TAXATION COOPERATING AS500IAitIONS-(1G76) PAGENO="0572" 558 * C. F. Peterson, Mississippi Pine Manu- facturers Association, Jackson, Miss. Missouri Forest Products Association, Jefferson City, Mo. Donald McNeil, National Christmas Tree Growers' Association, Milwau- kee, Wis. Thomas M. Higgins, National Council of Forestry Associaiton Executives, Columbus, Ohio. Ralph D. Hodges, Jr., National ~`orest Products Association, Washington, D.C. E. Howard Gatewood, National Hard- wood Lumber Association, Chicago, Ill. Henry H. Willins, National Oak Floon ing Manufacturers Association, Memphis, Penn. Robert E. Dougherty, National Parti- cleboard Association, Silver Spring, Md. Kendall S. Norcott, New Hampshire Timberland Owners' Association, Gorham, N.H. J. Lewis Dumond, New York Forest Owners Association, syracuse, N.Y. Ben F. Park, North Carolina Forestry Association, Raleigh, N.C. William J. Kidd, Northeastern Lum- ber Manufacturers Association, Inc., Glens Falls, N.Y. Thomas P. Brogan, Northern Hard- wood and Pine Manufacturers Asso- ciation, Inc., Green Bay, Wis. Thomas M. Higgins, Ohio Forestry As~ sociatlon, Inc., Columbus, Ohio. William V. Hooker, Oklahoma Fores~. try Assoclaiton, Ada, Okia. James B. Corlett, Oregon Forest Pro- tection Association, Portland, Oreg. Frank Per Bush, Oregon/Washington Silvicultural Council, Portland, Oreg. Carwin A. Woolley, Pacific Logging Congress, Portland, Oreg. John C. Fralish, Pennsylvania Fores- try Association, Mechanicsburg, Pa. Paul Bofinger, Society for the Protec- tion of New Hampshire Forests, Concord, N.H. Robert R. Scott, South Carolina For- estry Association, Columbia, S.C. John C. Milliner, Jr., Southeastern Lumber Manufacturers Association, College Park, Ga. William R. Ganser, Jr., Southern For- est Products Association, New Or- leans, La. George B. Kelly, Southern Forest Products Association, Atlanta, Ga. George Romeiser, Southern Hardwood Lumber Manufacturers Association, Memphis, Tenn. Martin Craine, Sopthern Oregon Tern- ber Industries Association, Medford, Greg. James J. Cox, Jr., Southwest Pine As- sociation, Phoenix, Ariz. John Van Mol, Tennessee Forestry As- sociation, Nashville, Tenn. B. R. Wagoner, Texas Forestry Asso- ciation, Lufkin, Pox. Carl Theiler, Timber Products Asso- ciation, Inc. of Michigan and Wis- consin, Crandon, Wis. Larry R. Frye, United Hardwood For- estry Program of Fine Hardwoods! American Walnut Association, Co- lumbia City, md. William B. Cooper, Virginia Forests, Inc., Richmond, Va. William H. Larson, Washington For- est Protection Association, Seattle, Wash. Joseph W. McCracken, Western Forest Industries Association, Portland, Oreg. Steele Barnett, Western Forestry and Conservation Association, Portland, Oreg. George A. Craig, Western Timber As- sociation, San Francisco, Calif. W. M. Graham, Western Wood Pre- servers Institute, Portland, Greg. H. A. Roberts, Western Wood Products Association, Portland, Oreg. The CHAIRMAN. Our next panelist is Mr. Gordon Powell. STATEMENT OP L GORDON POWELL Mr. POWELL. Mr. Chairman and members of the committee, my name is Gordon Powell. I am a forest economist employed by First National Bank of Mobile, Ala. We are today discussing a subject that is very important to private landowners all over the United States. In the south, nonindustrial, private timberlands comprise the majority of our timberland base. As you consider legislation to change the death tax laws, our timber industry appeals to you to help us make the timberland more pro- PAGENO="0573" 559 ductive. We need a higher timber productivity to meet several social needs. For instance, first example: Greater timber production will help to meet the needs of `our industry as we predict drastic increases in timber demand in the near future. Second example: Higher timber incomes from private land will increase tax revenues from income and death taxes. As you consider legislation to make death taxes serve social needs, may I suggest that you also consider how you may eliminate social problems caused by the application of present death tax laws. For instance: 1. Present law is causing private timberland to flow into the giant corporate holdings. You sec~ it takes a lot of woodland acres to gen- crate even a modest annual income from timber sales after property taxe~, income taxes, severance taxes and yield taxes have been paid. For estate tax purposes, a moderate tree farm represents a lot of wealth. Unless the owner happens to own a great deal more wealth of a higher yield, the estate tax will likely force a sale of his timber- land. Now the forest industries are not seeking to buy all the timberland in the country; but they are the only purchasers capable and willing to buy these high-value, low-yield tree farms. Of course, the net yield to the giant industries may be much higher than to the private tree farms, because the industries do not face the periodic assessment of the estate tax. 2. Present law is causing private timberland to be very, low in timber production. There are a number of tax disincentives th~t cause landowners, their executors and their heirs tO liquidate private timber stands before they have time to become productive. Please allow me to illustrate the nature of these problems. There are two basic ap~iroaches to maintaining high yields from our forests: One In the first case, we practice sustained yield management by growing a forest containing trees of many sizes and ages Periodi cally, we harvest the large, mature trees and establish seedlings to replace them. But the majority of the trees are in intermediate size and age categories; and we cultivate the forest to keep these inter- mediate trees growing in a healthy and high-quality condition. Two: In the second case, we manage many different sizes of even- aged stands. Each year we harvest older stands and plant new stands. But the majority of the stands are in intermediate sizes. In the case of Government owned and industry owned land, these forestry practices work quite well. But on private lands, foresters have not been nearly so successful. It takes more than a generation of owners-sometimes two or three -to develop a sustained yield forest. To be productive, the forest must be maintained so that the majority of the trees form a timber h~ise of intermediate sizes approaching maturity If this timber base is liquidated, the immature trees will not yield their potential and it will take many years to restore s~istained yield. In many cases, liquidation destroys even the future yield because the seed source is removed. PAGENO="0574" 560 But present ta~ law is causing accountants to overrule the foresters; so that landowners, executors and heirs liquidate the timber base. LandOwners liquidate the timber base to try to reduce the impact of estate tax by lowering the anticipated valuation. Executors face values ballooned by investment speculation. Because the land represents such a high value for tax purposes, but has such a low annual yield compared to the ballooned value, the timber is liquidated to pay taxes and costs of intorgeneration transfer of title. Heirs look at an estate tax basis that is a cost that can be fully recovered only by liquidating the timber base that would otherwise provide the annual yield. Somehow .the tax laws must be~ changed to cause private land- owners to want to protect thO timber base rather than to destroy it. At the same tin~e, we must be sure that we do not go to the other ex- treme to cause landowners to hoard timber that should be cut. May I suggest you concentrate on proposals that will overcome the social problems, meet social needs and increase tax revenues from private timber management. The most important recommendation is to allow an option to re- late the payment of that part of an estate tax assessment based on timber and land to the actual yield of the land under a sound man- agement program. Such an option should require a forest management plan, prepared or approved by licensed foresters or professional graduates of our forestry schools. That part of the tax resulting from timber and timberland value should be deferred as a~ lien against the property with payment ke~ycd to the future cutting schedule in the forest management plan. The interest rate should be very low to allow timber growth to overcome the interest accumulation. If the ne~ owner ~hould die, the remaining debt of the lien should be treated as a deduction against the value of the land and timber in the new estate tax appraisal. Bear in mind that this would be the second or third assessment ag~iTrst the existing intermediate timber stands that are being cultivated for high-yield harvests when they reach maturity. I know of no proposed bills to do exactly what I have suggested. The President has a proposal which is fairly close. As you consider legislative action I hope you will exert your influence to incorporate actions that will provide private landowners with incentives that will cause them to practice better timber management that will increase the flow of raw material for our industries and more revenue for the Treasury. Thank you. The/ CHAIRMAN. Thank you, Mr. Powell; Now, Mr. William E. Toweil of the American Forestry Association. We are pleased to hear you, sir. STATZMI~NT OP WILLIAM E. TOWELL Mr. T0wELL. Thank you, Mr. Chairman. I speak to you both as a forester and a conservationist about a very severe problem; that is the estate tax as it effects 4 million land- PAGENO="0575" 561 owners owning some 800 billion acres of priv~te nonindustrial~forest land which comprises 5~ percent of oui total commerce forest land~ area. These lands are not keeping pace with our needs for timbei, produc ing something less than half of what they are capable. Several years ago the American Forestry Association formed a task force to see what . might be done about this particular category of forest ownerships, and we found that lack of incentives was a major problem. One of these types of incentives that we put high priority on was some relief from taxation. The estate tax as now being administered, that is existing law, now- forces in many cases the liquidation of timber in order to pay the estate tax, and sometimes if the timber value is not there to pay this. tax then, it. forces the sale of the lands. Both of these actions are detrimental to the long term needs from these private non-industrial forests because timber is a long term crop, as has been pointed out.. The average ownership of forest land is only 20 or 30 years, yet a timber rotation may be all the way from 20 or 30 to .120 or 130, or- even 150 years. So continuity of ownership is extremely important. I would like to give you for the hearing files-not the record-a copy of the report from our task force which focuses on this timber- tax problem. , The CHAIRMAN. We would be pleased to a~cept it. Mr. TOWflLL. Also, `I would like to give you for the files and report by my colleague here on' the right, Mr. Powell, who may be a little modest, but.he presented to our task force a few years ago a case his- tory on adverse timber taxation. The CHAIRMAN. We will be pleased t~ have It. Mr Towm.t~ For your information, in some European countries a different approach to timber estates `is taken. While timberland is~ still subject to estate tax, timber is recognized as a long-term enter- prise rather than as an immediately salable commodity. The tax is consequently levied over an extended time period, so that the annual income from a properly managed forest may be used, incrementally,. to pay off the tax. In this manner, the estat~ tax may actually con- tribute to the promotion of forest managemen on private lands. Existing estate tax laws require valuation of forest land at its~ market value for estate tax purposes. The value of the land for gro*- ing timber may he well below its market value for subdivision or other purpo~es. When Confronted with the higher estate taxes brought on by the potential value of the land, the only alterrta~ives available to heirs of .the property are either sale of the land or liquidation of the timber. The law should provide valuation for estate tax pur- poses at its value as woodland if it is being managed for that pur-. pose, but if the land is sold or converted to some other use, there could be provisions for the goveriiment to recapture the estate taxes: ]ost. This is not a new principle because many States now have forest yield taxes for ad valorum taxes, `taxing timber at a reduced rat~ in its lower productive stages and then requiring `t yield t'ix when the timberis actually cut. By all of our investigations of estate taxes we consider this a very severe problem. It is prohibiting the practice of PAGENO="0576" 562 good forestry, as I pointed out to you in Mr. Fisher's home one evening, and we strongly recommend that some kind of provisions be made to ease this estate tax burden that is causing many of our forest stands either to be liquidated' or `the land sold. [The prepared statement follows:] STATEMENT or WILLIAM E. TOWELL, TIlE AMERICAN FORESTRY ASSOCIATION Mr. Chairman `and members of the Committee, I am William E. Towell, Executive Vice President of The American Forestry Association, a citizen conservation organization of 80,000 members. Our involvement in forestry and conservation dates back to 1875 when our Association was formed. We appear today in behalf of the four million owners of `small, nonindustrial forests who own approximately 300 million acres or 59 percent of all c~m- mercial forest lands in America. Several years ago, The, Am~riean Forestry Association convened a commit- tee of experts in many field to study the problems of these small woodlot owners. Our group, known as The Trees For People Task Force, focused on the obstacles to continuity of ownership and management of this large segment of our nation's forests. We publisl~ed a report, "The Challenge of Private Woodlands," a copy of which I offer for your Committee files. Taxation was identified as one of the' major problems confronting the small forest owner and particularly the estate tax which often forces liquidation of forest properties in order to pay Inheritance levies. May I quote just a few paragraphs from this report: the Federal' estate tax is not particularly conducive to the imple- mentation of forest management practices by private owners. Under the estate tax timberland is assessed and taxed at market values, as are other commodities and holdings which are part of the estate. This, in conjunction with the inheritance tax. treatment applied to timber, often leads executors and administrators to cut and sell all the timber available to pay off the estate tax (since the revenue so derived Is not subject to capital gains or income tax under the inheritance tax provisions). "The only solution to this `prob~~m currently available is estate planning. Through complicated estate planning, private forest management can suc- ceed; but the average forester or attorney Is not capable of making a forest plan or an estate plan that can overcome tax burdens. Recently, some banks have brought in specialized forestry estate planners and forest economists in an attempt to offer forest management and estate plans, but the success of such efforts has bien limited. "In some Europen countries, a different approach to timber estates is taken. While timberland is still subject to estate tax, timber Is recognized as a long- term enterprise rather than as an immediately' salable commodity. The tax Is consequently levied over an extended time period, so that the annual Income from a properly managed forest may be used, Incrementally, to pay off the tax. In this manner, the estate tax may actually contribute to the promo- tion of forest management on private lands. "The federal estate tax, then, as it presently applies to private forest land, destroys the incentives of an owner to grow timber. With some simple changes in appraisal for and collection of estate tax for timberland, the federal tax- ation could provide positive incentive for owners of private land to engage in the practice of growing trees for harvest." Existing estate tax laws require valuation of forest land at Its market value for estate tax `purposes. The value of the land for growing timber may be well below its market value for subdivision or other purposes. When con- fronted with the higher estate taxes brought on by the potential value of the land, the only alternatives available to heirs of the property are either sale of the land or liquidation of the timber. The law should provide valuation for estate tax purposes at its value as woodland if it is being managed for that purpose, but if the land is sold or converted to some other use, there could be provisions for the government to recapture the estate taxes lost. Many states already have yield tax laws which tax growing timber at a re- duced rate when there is little or no income `to its owner, hut which leVy a higher yield tax when timber is ` cut and sold. The same principle should be applied to federal estate taxes. PAGENO="0577" 563 This is a serious problem reported to us by consulting foresters and service foresters from all across America. Mr. Chairman. We are not tax experts, but we are concerned about keeping forest lands growing trees. You have the means of encouraging better forestry *and greater permanency of forest land ownership. This will benefit not just the owners but all citizens who profit from attractive, growing forests which cover one-third of our total land area in America. It seems to us more efficient to encourage these private land- owners through tax incentives than through costly subsidies and other gov- ernment programs alone. We urge you to give this problem serious consider- ation. The CHAIRMAN. Thank you, Mr. Towell. Our next panelist is Richard Rechter, chairman of the board of the National Limestone Institute. We are happy to hear you. STATEMENT OP RICHARD P. RECHTER Mr. RECHTER. Thank you, Mr. Chairman, members of the coin- mittee. For the record, I am Richard P. Rechter, chairman of the board of the National Limestone Institute, and executive vice president and treasurer of the Ralph Rogers & Co., Inc., of Bloomington, md. The National Limestone Institute is a trade association with ap- proximately 600 members who operate some 2,000 pits and quarries. The reason I am here today is to testify to the fact that estate tax reform is much needed if our industry is going to survive as basi- cally family-owned enterprise. Historically, the crushed stone in- dustry was started around the turn of the century by contractors looking for aggregate to build country roads and State highways. After the road was completed, the small pit or quarry was abandoned. As the market for aggregates grew, most of the small pits were re- activated by farmers and contractors or other businessman to furnish the local needs. In 1974, the Bureau of Mines has records of some 5,431 operations. I have no way of knowing how many of these are small family busi- nesses, as the Bureau doesn't have that information broken down. But from my experience, the past 10 years of our industry, almost every sale of a quarry has been from a family corporation to a large con- glomerate. It is inconceivable to hear all the furor raised by the Congress over the information they receive of monopolies by large corporations, when it is the Congress' tax policies which force the sale of small businesses to pay estate taxes. The average quarry sells approximately 400,000 tons of stone an- nually. With the average price of stone being around $2 a ton, this generates a gross sale of $800,000. The amount of equipment it takes to produce and sell these volumes would cost anywhere from $750,000 to $1.5 million. The crushed stone business is not unlike other busi- nesses. We operate on a 5-percent to 10-percent after tax profit on sales. I have been informed by our legal counsel, and accountants, that the method of valuation the Internal Revenue Service uses is a weighted book value and multiple of earnings. These multiples run between 10 and 16; and using a little high school arithmetic, I am 68-872 0 - 76 - 37 PAGENO="0578" 564 sure you can see why our industry is forced to sell when the founder or majority stockholder dies I ask the comnuttee's indulgence because unlike many of you, I am not an attorney and know very little about tax law But I have always wondered if the estate tax is a revenue producing or social tax. By social, I mean a means by which to break up large concen- trations of capital I do not have the amount of money that this tax brings to the Federal coffers, but I seriously doubt that it has any appreciable effect on the Federal budget The impact of the tax does have this efFect on quarry operations It destroys a taxpaying en tity It can result in unemployment, as many times when a small operator is bought out for competitive reasons that operation is left dormant And, of course, the only people in the market place with ready cash are the large conglomerates I would like to ask the committee's consideration on the following points 1 We would like to see the amount of tax exemption raised horn ~60,000 to $400,000-half of this would only take care of the in flationary figure and we believe more than this is essential if family businesses are to be protected 2 To broaden the revenue code to allow the redemption of stock held by the testator In addition, there should be some method fot capital retention to accomplish the redemption As it is now, st ite planning is not a legal reason for the building of liquid assets in a corporation. 3 To broaden the regulations for the installment payment pian which should be 25 years with a reasonable interest rate This is be coming increasingly important because now the estate tax is due within 9 months and this makes outside financing impossible 4 Finally, we would like to see the tax rates lowered In many cases they are confiscatory in and of themselves and when combmed with State taxes, they are ridiculously high We are not prepared to quote figures, but think that one way ot handling this might be by raising the size of the estate applicable to a given rate For example-and this is used only for illustrative pui poses and is not a recommendation-an estate of less than $500,000 is taxed at a rate of 32 percent. The size of the estate covered by this bracket could be raised to $1 million, which is currently taxed at 37 percent. Also, we think it would be a good idea to tie the size of the estate in each bracket to the Consumer Price Index, thus insulating it against inflation. [The prepared statement follows:] STATEMENT OF RICHARD P RECHTER CHAIRMAN ON BEHALF OF THE NATIONAL LIMESTONE INSTITUTE INC We want to thank the Committee on Ways and Means for this opportunity to present the National Limestone Institute s views on the revision of oui Estate and Gift Taxes-a matter we feel is of extreme and urgent importance to the small businesses of this country who, for the most part, have a strong desire to preserve the family-owned business for future generations. For the record I am Richard P Rechter Chairman of the Board of the National Limestone Institute, and Executive Vice-President and Treasurer of the Ralph Rogers and Company, Inc. of Bloomington, Indiana. Appearing with me today is Mr. Clark C. MeClinton, a Past Chairman of the Board of NLI and President of McClinton Brothers Company of Fayetteville Arkansas PAGENO="0579" 565 The National Limestone Institute is a trade association representing some 600 members in 34 states. These 600 members operate some 2,000 quarries throughout the United States. Most of the companies in the limestone indus- try are family-owned enterprises who are well aware of the tremendous bur- dens of our current estate and gift tax laws. Historically, the crushed stone industry was started around the turn-of- the-century by contractors looking for aggregate to build county roads and state highways. After the road was completed, the small pit or quarry was abandoned. As the market for aggregates grew, most of the small pits were reactivated by farmers and contractors or other businessmen to furnish the local needs. As of 1974, the Bureau of Mines has on record some 5,431 opera- tions. I have no way of knowing how many of these are small family busi- nesses, as the Bureau does not have that information broken out. But from my experience, during the past ten years of our industry, almost every sale of a quarry has been from a family corporation to a large conglomerate. It is inconceivable to hear all the furor raised by the Congress over the information they receive of monopolies by large corporations, when it is the Congress' tax policies which force the sale of small businesses to pay estate taxes. The average quarry sells approximately 400,000 tons of stone annually. With the average price of stone being around $2.00 a ton, this generates gross annual sales of $800,000. The amount of equipment it takes to produce and sell these volumes would cost anywhere from $750,000 to one and a half million dollars. The crushed stone business is not unlike other businesses; we operate on a 5-10% after tax profit on sales. I have been informed by our legal counsel and accountants, that the method of valuation the Internal Revenue Services uses is a weighted book value and multiple of earnings. These multiples run between ten and 16; and using a little high school arithmetic, I am sure you can see why our industry is forced to sell when the founder or majority stockholder dies. I ask the committee's indulgence because unlike many of you, I am not an attorney and know very little about tax law. However, I have always wondered if the estate tax is a revenue producing or social tax. By social, I mean a means by which to break up large concentrations of capital. I do not have the amount of money that this tax brings to the Federal coffers, but I seriously doubt that it has any appreciable effect on the Federal budget. The impact of the tax does have this effect on quarry operations: It destroys a tax paying entity; it can result in unemployment, as many times when a small operator Is bought out for competitive reasons that operation is left dormant. And, of course, the only people in the market place with ready cash are the large conglomerates. This committee currently has before it several proposals which, in various ways, wOuld alter the current laws dealing with Estate and Gift Taxes. We have looked at many of them and find many proposals with which we are in sympathy. However, rather than discussing each of the proposals, we would like to touch briefly on those points which concern us most. First among our concerns is the existing $60,000 exemption allowed for the estate of each U.S. citizen or resident. The great majority of legislation intro- duced to deal with estate and gift law recommends that the exemption be increased to $200,000. The $200,000 figure, as we understand It, represents the $60,000 exemption provided for in the 1942 Act plus an inflation factor. Or, put another way, $60,000 in 1942 is worth about $200,000 in 1976. There is, at least in our minds, no question that the exemption ought to be Increased to at least $200,000. However, we would like to urge increasing the exemption to $400,000 and tie it to the Consumer Price Index so that another 34 years will not elapse before it Is increased again. My understanding is that Senator Dewey Bartlett of Oklahoma has Intro- duced legislation to raise the exemption to $400,000. Also, we have been in- formed by the Senator's staff that the estate tax exemption under the 1939 law was $100,000 and that the $400,000 figure is equal in 1976 dollars to $100,000 In 1939. While I fully realize that very few have recommended an increase in the exemption to $400,000, I do hape that the Committee will give our recommendation its full consideration. I think, Mr. Chairman, it all goes back to what I said earlier. We must ask ourselves the basic question : What are we trying to achieve through estate PAGENO="0580" 566 and gift taxation? Certainly one of the purposes is to raise revenue for the Treasury. But, at the same time, are we trying to make the big grow bigger at the expense of the small? For, if we are, then the current law is a complete success, at least with respect to our industry where, as pointed out earlier, this is definitely happening. I, for one, do not think that is the purpose of the law. Certainly we are not trying to abandon the small businessman for I think we can all agree that there is a sound economic advantage to the country in passing the small business from one generation to another. We have no bone to pick with the large companies, but we must preserve the small busi- ness which, from figures we have seen, do about 48 percent of the gross business production in this country. Indeed, 55 percent of the nonagriculture workers in the private sector are employed in the small business sector. In 1953, the Congress formally recognized the importance of small businesses when it declared it to be the policy of the Government to "aide, counsel, assist, and protect . . . the interest of small business concerns in order to preserve free competitive enterprise . . ." Certainly this is still the policy of our Government, and, if we are to meet the objective of that policy, we must enact many of the changes we and others are recommending. Secondly, Mr. Chairman, we would like to see the Revenue Code broadened to allow the redemption of stock to include any stock held by the testator. In addition, there should be some method for capital retention to accomplish the redemption. As it is now, estate planning is not a legal reason for the building of liquid assets in a corporation. Thirdly, we must revise existing law to broaden the installment payback provisions so they do not work an unreasonable hardship on small businesses. Here, we are very much in sympathy with *the proposal put forth by the Administration which would allow a five-year moratorium on the payment of estate taxes and provide an additional 20 years for full payment. However, we op.pose the Administration's $300,000 ceiling. This is extremely important because the current regulations call for full payment, except where undue hardship can be shown, in nine months making outside financing impossible. This provision, if enacted, would go a long way toward easing the burden currently placed on small businesses. We would also like to see the interest rate charged during the payback period made more reasonable. Here again, the Administration's four percent figure is in line with our thinking. Finally, we would like to see the tax rates lowered. In many cases, they are confiscatory in and of themselves and when combined with state taxes, they are ridiculously high. We are not prepared to quote figures but think that one way of handling this might be by raising the size of the estate to which a given rate is applicable. For example (and this is used only for illustrative purposes and is not a recommendation), an estate of less than $500,000 is taxed at a rate of 32 percent. The size of the estate covered by this bracket could be raised to $1,000,000 which is currently taxed at 37 percent. Also, we think it would be a good idea to tie the size of the estate in each bracket to the Consumer Price Index, thus insulating it against inflation. Mr. Chairman, that concludes my specific remarks on the revision of the laws dealing with estate and gift taxation. We urge the committee to give careful consideration to what we have said here today. We also urge the committee and the Congress to act expedi~tiously on this long overdue re- vision. We think there could be no more fitting recognition of the plight of the small businessman during this Bicentennial Year than the enactment of these revisions. Now, Mr. Chairman, I would like to have Clark McClinton relate to you and the members of this committee some of the reasons why he recently sold his family business. Mr. RECIETER. I have with me Mr. Clark McClinton, a member of NLI, who is going to relate some of the reasons for his decision to sell his business. STATEMENT OP CLARK C. MoCLINTON Mr. MCCLINTON. Thank you, Mr. Rechter. Mr. Chairman and members of this very prestigious committee. PAGENO="0581" 567 I am privileged to have the opportunity as a country boy from Arkansas to be able to appear before such a group as this. I want to bring to your attention some of my reasons for selling the business that I started 30 years ago this next month with the sum total of about $5,000 to go into the crushed stone business, and also into the construction business. During this period of time we managed after long hard years of work to begin to put together an organization and a company that gradually became fairly well to do, but it took a lot of capital out- lay to be able to do this due to the rate of inflation existing during this period of time. As the company became better off I talked to my accountant and to my tax lawyers, and they began telling me I needed to try to put some money aside to pay estate taxes. I never had been worried about estate taxes prior to that time because I didn't know there was any such thing. So I began to try to find out the amount I would need to be able to pay the estate taxes. I also ran into this conflict of just how the Internal Revenue Service would value the estate of a closely held corporation. My ac- countant and lawyers would always say, "Clark, this the high valuation figure and this is the low valuation figure, you will just have to make a choice and try to allow enough to be able to keep the company in a fairly liquid condition at your death." So I found myself over the years buying more insurance and more insurance until 2 years ago prior to selling out I found that I was paying somewhere in the neighborhood of $100,000 of life insurance premiums on myself, my wife, and my son to take care of the situ- ation. Generally that takes a great deal of cash flow out of a small busi- ness that we need to put back into the business to be able to carry on the work. I began to realize then that in doing this I was probably fighting a losing battle because of the rate of inflation, because the further we would go, the more equipment costs. I would like to go into that. In 1948 we bought a motor grader to use for $9,500. In 1965 we bought a similar machine, similar horse- power, and work capabilities, for between $21,000 and $22,000. In 1974, 2 years ago this spring, we bought that same machine at about $48,000. And today that machine sells for in excess of $60,000. That is true in most all the equipment we buy. It takes an enor- mous amount of capital to keep up with it. I came to realize in all probability I was fighting a losing battle in this. I am not saying this is the only reason that we sOld out, but it was one of the contributing factors to it. I could not see continuing to pay my life insurance-I am getting to the age where I could not buy any more life insurance-and never knowing how much estate tax would actually be levied, and also the fact that there is such a short period of time to pay the taxes-I be- lieve it is nine months-that it would create a great hardship on my heirs to be able to raise the money to pay the estate taxes to keep this business going. PAGENO="0582" 568 So~ as a result, or that was one of the reasons that 2 years ago we decided to sell out and we did so I think we as a Nation need to take a long look at our estate taxes and try to make it easier for the small business to continue as an entity in its locality, because it does create jobs It creates many benefits to the local area Also that applies to forest areas, farming areas, and all the others We certainly need to take a look at it and try to get the estate taxes more realistic to our daily economy because it is much different today than it was when this was first passed I believe in 1939 the exemption was $100,000, and then it dropped in 1942 to $60,000 minimum, and still remains at that level. Thank you for allowing me to appear before you. The CHAIRMAN. Thank you, Mr. McClinton, for a very articulate spontaneous statement We appreciate the fine testimony this morn ing Are there any questions ~ Mr STErnER Mr Chairman, I wonder if I may ask Mr Reciter a question You raised in your testimony the issue of property valu ation The forestry people may wish to comment because you have a very different problem You don't have an annual yield in the same way that a quarry has an annual yield, or a farm has an annual yield. How do you propose to accomplish any change-I don't see one in any of your recommendations-on the issue of the present posture of the Internal Revenue Service. For example, one of the suggestions that has been made that I happen to think makes some sense is to capitalize earnings to detei mine value This would provide some degree of certainty as to value Do you have any comments on that? Have you made any recommen- dations? Does the Limestone Institute have any feelings on that? Mr. RECHTER. I personally have some feelings because I have had some dealings with the Internal Revenue Service over the valuations of corporation, and the only thing you can say is they are never going to use the same formula twice. My experience has been that they try to take comparables. They try to take a company that is as comparable to the business that you are in, that is freely traded over some exchange, and they take those multiples-whether it is in Vul can Materials or in Ashland Oil-and they compare it with a corn pany maybe 2 percent of its size, and then they weight that with the book value. You may be stuck with some multiples, some as high as 40 times earnings. I am sure that the National Limestone Institute would be very, very pleased to see some hard and fast fair method of the determin- ing of the value of its quarries and pits. I am sure that the Internal Revenue Service has been struggling with something, because what- ever they come up with, if it is unreasonable we end up in the tax courts, which is expensive to both of us. It takes years, not just months but years, to get some of these valuation questions worked out. I am afraid that I certainly don't have the capabilities to make any recommendations at this time. I would certainly like the oppor- tunity to listen to any that anybody else has. PAGENO="0583" 569 Mr. STErnER. As we go along-and I see Bob Koch is here-as something is developed by the committee I hope you will get back to us. My judgment is that if this committee does anything, then one of the best things that we can do without regard to the issue ?~ exemp- tions and marital deductions and all of those kinds of things is to try and solve what is to me at least a very real problem-this whole question of how you determine value and what formula you develop to provide far more certainty than what is now the law. So as time develops I hope you will look at this issue. I hope yoi:i will watch it, and I hope you will then get back to us on that. Let me try to figure out if I can from the perspective of those in the forest business, how, if you want to capitalize earnings, to deter- mine value, do you handle the problem you posed to us where you don't have annual earnings. Also, how do we avoid creating a ioop- hole. What would prevent an individual from getting into the busi- ness, not doing anything particularly but just getting in and holding on for some tax advantage from an estate planning point of view? How do you handle that problem? What comments do you have? Mr. WELLMAN. I think you raised two questions, sir-regarding the capitalization-in Maine we have what we call a tree growth tax law for purposes of establishment of ad valorem taxation. I believe this is very similar to the Minnesota law. This is a measured growth data on the various kinds of stands which is done by the State. The State then attempts to establish a value per unit of that growth and those two figures multiplied by 10-capitalized at 10, become the value of that land for the purpose of taxing under the ad valorem law. I would suppose that a very similar method could be devised. Obvi- ously it would be more complicated as you got into different kinds of stands. I know Georgia has been struggling with this for lo these many years. I think the other part of your question is how do you establish that an individual landowner is in the bona fide commercial timber business? And I think again there are ways of getting at this. I think there are a number of items that we could look to see whether he is in fact doing this. Does he have a forestry manage- ment plan? Is he under some sort of contract with either firms such as ours or-again I am talking about New England-New England Forestry Foundation. Is he a member of the tree farm system. What is the record of his efforts in this regard? You are quite correct that it might be in certain instances sound forestry management to do nothing. But I think the taxpayer-the decedants in my example-in 5 years ought to be able to prove or his executor ought to be able to prove that he was doing nothing based on some sort of rational plan and recommendation. I think those records are in the taxpayers files today, and I think if it came down to what you are talking about, regulations could be prepared drawing on this data which would solve the problem you raise. Mr. STErnER. Would it be possible for you, if you so desire, to put some meat on the bones of any recommendations, or ideas that you have, and get back to us so that we can make it part of the record as we go down the road? PAGENO="0584" 570 Mr. WELLMAN. I will be glad to. [The following was subsequently supplied for the record:] To qualify for . . . (recommended special estate tax treatment) . . . lands held by a private estate, a private landowner, a private trust, or a family-owned corporation must be regulated according to prescriptions in a forest management plan, prepared or approved by a licensed forester (in states where forestry license laws exist) or by professional forestry graduates of a four year college or university forestry curriculum (in states without forestry license laws). The management plan should include a cutting schedule based on the silvicuitural needs of the forest or upon the capability of the forest to produce sustained yield under the plan. The cutting schedule must be followed to retain eligibility, unless a forester qualified to prepare or approve forest management plans recommends an amendment to the active plan because of changes in the timber market which make the recommended amendment more applicable than earlier recommended activity to achieve the silvicultural objectives. SEVEN ISLANDS LAND Co., Bangor, Maine, March 19, 1976. Hon. WILLIAM A. STEIGER, Longworth House Office Building, Washington, D.C. DEAR REPRESENTATIVE STEIGER: Per your request, I am enclosing a copy of the Maine Tree Growth tax law which shows how we have capitalized the value of growth to establish a value for all ad valorem tax. For us in Maine there would be no problem to use this value for Estate Tax purposes, but it might be a fairly difficult process to establish for each and every state. I am aware that Georgia and many others have grappled with the problem for years. Really, the valuation for Estate Tax purposes, of commercial timberland as such is not too difficult a matter using cruise data and comparable sales figures. The only real valuation problem arises when IRS tries to value the timber- land on recreational or development land. Sincerely, BRADFORD S. WELLMAN, Chairman of the Board. Enclosures. PAGENO="0585" 571 STATE OF MAINE TREE GROWTH TAX LAW (Title 36, M .R .S .A., Sections 571 through 584; as enacted by Chapter 616, Secflon 8, P ,L. 1971; as amended by Chapter 308, Section 1 through 18, P.L. 1973) Effective May 7, 1973 Issued by BUREAU OF TAXATION State House, Augusta, Maine 04330 Appropriation No. 1048 1973 PAGENO="0586" 572 Sec. 571. Title This subchapter may be cited as the "Maine Tree Growth Tax Law". Sec. 572. Purpose It has for many years been the declared public policy of the State of Maine, as stated in sections 563 to 565, to tax all forest lands according to their productivity and thereby to encourage their operation on a sustained yield basis. However, the present system of ad valorem taxation does not always accomplish that objective. It has caused inadequate taxation of some forest lands and excessive taxation and forfeiture of other forest lands. It is declared to be the public policy of this State that the public interest would be best served by encouraging forest landowners to retain and improve their holdings of forest lands upon the tax rolls of the State and to promote better forest management by appropriate tax measures in order to protect this unique economic and recreational resource. This subchapter implements the 1970 amendment of Section 8 of Article IX of the Maine Constitution providing for valuation of timberland and woodlands according to~ their current use by means of a classification and averaging system designed to provide efficient administration. Therefore, this subchapter is enacted for the purpose of taxing forest lands generally suitable for the planting, culture and continuous growth of forest products on the basis of their potential for annual wood production in accordance with the following provisions. Sec. 573. Definitions As used in this subchapter, unless the context requires otherwb.e. the following words shall have the following meanings: 1. Assessor. "Assessor" moans the State Tax Assessor with respect to the unorganized territory and the respective municipal assessors with respect to the organized areas. 2. Average annual net wood production rate. "Average annual net wood production rate" means the estimated average net usable amount of wood one acre of land is growing in one year. :i. Forest land. "Fprest land" means land used primarily for growth of trees and tore'4 products but shall not mcludc ledge m irsh opcn s~amp hog ~ iter and similar areas, which are unsuitable for growing a forest type even though such areas may exist within forest lands. Land which would otherwise be included within this definition shall not be excluded because of multiple use for public recreation. 4. Forest type. "Forest type" means a stand of trees characterized by the predominance of one or more groups of key species which make up 75 percent or more of the sawlog volume of sawlog stands, or cordwood in poletimber stands, or of the number of trees in seedling and sapling stands. 5. Hardwood type. "Hardwood type" means forests in which maple, beech, birch, oak, elm, basswood, poplar and ash, singly or in combination, comprise 75 percent or more of the stocking 6. Mixed wood type. "Mixed wood type" means forests in which neither hardwoods nor softwood comprise 75 percent of the stand but are a combination of both 7. Softwood type. "Softwood type" means forests in which pine, spruce. fir, hemlock, cedar and larch, singly or in combination, comprise 75 percent or more of the stocking. 8. Stumpage value. "Stumpage value" means the average value of standing timberS before it is cut expressed in terms of dollars per unit of measure as determined by the State Tax Assessor. -2 PAGENO="0587" 573 9. Value of the annual net wood production. Value of the annual net wood production.' means the average annual net wood production rate per acre for a torest type multiplied by the weighted average of the stumpage values of all species in the type. Sec. 574. Applicability This subchapter shall have mandatory application to any parcel which contains more than 500 acres of forest land. An owner of a parcel containing forest land of 500 acres or less may apply at his election by filing with the assessor the schedule provided for in section 579: except that this subchapter shall not apply to any parcel containing less than 10 acres of forest land. Theelectionto apply shall require the unanimous consent of all owners of an interest in a parcel, except for the State of Maine which is not subject to taxation hereunder. Sec. 575. Administration: regulations * The State Tax Assessor shall have the powers and duties provided in this sub- chapter. He shall adopt and amend such rules and regulations as may be reasonable and appropriate to carry out these responsibilities. He may contract with municipal. State and Federal Governments or their agencies to assist in the carrying out of any of his assigned tasks. He is authorized to hire such technical assistance as may be required for the performance of his assigned tasks. He is authorized to request such - technical assistancefrom the Forestry Department or the Department of Finance and Administration as the respective department may be able to provide. See: 576. Powers and duties - -. The State Tax Assessor shall determine the average annual net wood production rate for each forest type described in section 573. subsections 5 to 7. in each counts to be used in determining valuations applicable to forest land under this subchapter. on the basis of the surveys of average annual growth rates applicable in the ~tate made from time to time by the United States Forest Service or by the Maine Forestry Department. The growth rate survys shall be reduced by 30 percent to reflect the growth which can be extracted on a sustained basis. The rates shall be determined after passage of this subchapter. and when determined shall remain in effect without change for each county through the property tax year ending March 31, 1975. ln 1974 and in every 10th year thereafter, the State Tax Assessor shall review and set such rates for the following 10 year period in the same manner. The State Tax Assessor shall determine the average stumpage value for each forest type described in section 573. subsections 5 to 7, applicable in each county, or in such alternative forest economic regions as he may designate, after passage of this sub- chapter and in each even-numbered year thereafter, taking into consideration the prices upon sales of sound standing timber of that forest type in that area during the previous 2 calendar years. and such other consideration as he deems appropriate. The proportions of the various species making up the type are to be used in the computations of the average annual net wood production rates and average stumpage values for each forest type and the proportions of the various products are to be used in the computations of average stumpage values. After the State Tax Assessor has made the foregoing determinations, he shall apply a 10 percent capitalization rate to the value of the annual net wood prbduction to determine the 100 percent valuation peracre for each forest type for each area and shall state the wood-production rates and values used to compute same. The State Tax Assessor shall hold one or more public hearings, with such reasonabli notice to the public as he shall determine, upon the foregoing matters to be deter- mined, shall provide for a transcript thereof and shall issue an order or orders stating said determinations on or before August 1. 1972 and on or before June 1st biennially thereafter.The State Tax Assessor shall give public,notice of such orders by certifying a copy of such orders to the Secretary of State and in such other manner as he determines reasonable. 3. PAGENO="0588" 574 The State Tax Assessor shall place such orders on file in the Bureau of Taxation and shall certify and transmit such orders to the municipal assessors of each municipality with respect to forest land therein on or before November 1st of each year, com- mencing November 1, 1972. Sec. 576-A. Valuation of areas other thab forest land Areas other than forest land within any parcel of forest land shall be valued on the basis of fair market value. Sec. 577. Reduced valuation under special circumstances 1. In the case of forest land areas exceeding one acre which on January 1. 1972 did not contain more than 3 cords per acre of wood which was merchantable for forest products, the valuation shall be reduced by 50 percent for a period of 10 property tax years, from April 1, 1973 through March 31, 1983. 2. In the case of forest land areas upon which, at any time after January 1, 1972 the trees are destroyed by fire, disease, insect infestation or other natural disaster, so that the area contains not more than 3 cords per acre of wood which is merchantable for forest products, the valuation of that specific land area shall be reduced by 75 percent for the first 10 property tax years following the loss. :i. In order to obtain a reduced valuation, the landowner shall make a written request to the assessor on or before January 1st the ureceding tax year. Dresentinc facts in affidavit form which meet either of the foregoing requirements. The assessor may investigate the facts, utilizing the procedures set forth in section 579, and shall then determine whether the requirements for reduced valuation are met. if the requirements are met, such forest land areas shall be assesed on the reduced basis herein provided. 4. In determining the applicability of this section, the assessor may request afreport and recommendation from the Forest Commissioner. Sec. 578. Assessment of tax I. Organized areas. The piunicipalasséssors shall adjust the State Tax Assessor's 100 percent valuation per acre br eaco forest type for their county by whatever ratio, or percentage of current just value, is then being applied to other property within the municipality to obtain the assessed values. Commencing April 1, 1973, forest land in the organized areas subject to taxation under this subchapter shall be taxed at the property tax rate applicable to other property in the municipality, which rate shall be applied to the assessed values so determined. If the April 1, 1973 total assessed valuation of forest lands under this subchapter in a municipality is more than 10 percent less than the April 1, 1972 total assessed valuation of such forest lands in that municipality, the assessors shall adjust the April 1, 1973 assessed values of such forest lands proportionately back to a 10 percent aggregate change. In subsequent tax years, in any municipality where the aggregate April 1, 1972 assessed valuation of forest lands exceeds by more than 10 percent the aggregate valuation of the same lands under this subchapter, the municipality shall have a valid claim against the State to recover the taxes lost by reason of such loss in valuation exceeding 10 per- cent, upon proof of the facts in form satisfactory to the Commissioner of Finance and Administration. Such claims shall be presented to the Legislature next convening, the assessed values determined under this section shall first be reflected in the ins State Valuation of Municipalities. 2. Unorganized territory. The State Tax Assessor shall adjust the 100 nercent valuation peracre for each type for each county by such ratio or percentage as is then being used to determine the state valuation applicable to other property in the unorganized territory to obtain tne assessed values. Commencing April 1, 1973, forest land in the unorganized territory subject to taxation under this subchapter shall be taxed at the state property tax rate provided in section 451, applicable to other property in the unorganized territory, which rate shall be applied to the assessed -4- PAGENO="0589" 575 ~alucs so determined. If the April 1, 1973 total assessed valuation of forest lands under this subchapter for the entireunorganized territory is more than 10 percent less than the April 1, 1972 total assessed valuation of such forest lands for the entire unorganized territory, the State Tax Assessor shall adjust the April 1, 1973 assessed values of such forest lands proportionately back to a tO percent aggregate change. t'pon collection by the State `lax Assessor, such taxes shall be deposited in the General Fund in accordance with section 342. The assessed values so determined shall he used in the 1973 State Valuation of the unorganized territory. :3. 1)ivided ownership. In cases of divided ownership of land and the timber and grass rights thereon, the assessor shall apportion 10 percent of the valuation to the land and 94) percent of the valuation to the timber and grass rights. Sec. 579. Schedule, investigation The owner or owners of forest land subject to taxation under this subchapter shall submit a signed schedule in duplicate on or before November 1, of the year preceding that in which such land first becomes subject to taxation under this subchapter, to the assessor upon a form to be prescribed by the State Tax Assessor, identifying the land to he taxed hereunder, listing the number of acres of each forest type, showing the location of each forest type and representing that the land is used primarily for growth of forest products. Such schedules may be required at such other times as the ass~ssor may designate upon 90 days' written notice. The assessor shall determine whether the land is subject to `taxation hereunder, shall classify such land as to forest type, and shall notify the owner of such deter- mination prior to the following March 1st. If such notification is not given, the assessor shall be deemed to have denied taxation hereunder on that date. The land shall be so taxed until it is reclassified or is withdrawn from under this subchapter. The assessor or the assessor's duly authorized representative may enter and examine the forest lands under this subchapter for tax purposes and may examine into any information submitted by the owner or owners. Upon notice in writing by certified mail, return receipt requested, or by such other method as provides actual notice, any owner or owners shalt appear, before the assessor, at such reasonable time and place as the assessor may designate and an- swer such questions or interrogatories as the assessor may deem necessary to obtain material information about said lands. If the owner or owners of any parcel of forest land subject to taxation under this subchapter fail to submit the schedules under the foregoing provisions of this section or fail to provide informatioh after notice duly received as provided under. this section such owner or owners shall be deemed to have waived all rights of appeal pursuant to section 583 for the next property tax year except for the determination that the land is subject to taxation under this subchapter. It shall l)e the obligation of the owner or owners to renort to the assessor any change ot use or changc of forest type of land subject to taxation hereunder. If the owner or owners fail to report to the assessor a change of use as required by the foregoing paragraph of this section, the assessor may collect such taxes as should have been paid, shall collect the penalty provided in section 581, and shall assess an additional pena~ty of 25 percent of the foregoing penalty amount. The assessor may waive the additional penalty for cause. For the purpose of this section, the acts of owners specified in this section may be taken by an authorized agent of an owner. Sec. 5110. Reclassification Land subject to taxes under this subchapter may be reclassified as to forest type by the assessor upon application of the owner with a proper showing of the reasons justifying such reclassification or upon the initiative of the respective assessor where the facts justify same. PAGENO="0590" 576 Sec. 581. Withdrawal If the assessor determines that land subject to this subchapter no longer meets the requirements of this subchapter the assessor may withdraw the parel from taxation under this subchapter The owner of land subject to this subchapter may atian~ time request ~ithdra~al of any parcel or portion thereof from taxation under this sub chapter by certifying to the assessor that the land is no longer used primaril~ for growth of forest products In the case of withdrawal of a portion of a parcel the owner as a condition of v~ith dra~al shall file with the assessor and upon granting of ~~ithdra~al in thc ap plicable registry of deeds a plan prepared by a registered surveyor showing the arca v~ithdrawn and the area remaining under this subchapter In the c se of ~ithdra~al of a portion of a parcel the resulting portions shall be treated thereafter as separate parcels under section 708 In either case and except when the change is occasioned by a traisfer to the State or other entity holding the power of eminent domain resulting from the exercise or threatened exercise of that power withdrawal shall impose a penalty upon The os~ ncr ~ hich shall be the greater of (a) an amount equal to the taxes ~%hich would have been assessed on the first day of April for the 5 tax years or any lesser number of tax sears starting with the year in which the property was first classified preceding such ~ ith drawal had such real estate been assessed in each of those years at its fair market value on the date of withdrawal less all taxes paid on said real estate over the preceding 5 years and interest at the leg~'1 rate from the date or dates on s~hi.h said amounts would have been payable or (b) an amount computed by multiplying the amount if an~ by which the fair market value of the real estate on the date of ~ith drawal exceeds the 100 percent valuation of the real estate pursuant to this sub chapter on the preceding April 1st by the following rates 10 percent from April 1 1973 to March 31, 1978, 20 percent from April 1, 1978 to March 31, 1983 and 3() percent after March 31, 1983. Such penalties shall be paid to the assessor as additional property taxes upon with- drawal. Upon withdrawal the lands shall be rolieved of the requirements of this subchapter immediately and shall be returned to taxation under the Maine statutes relating to the taxation of real property, to be so taxed on the following April 1st. Sec. 581-A. Sale of a portion of a parcel of forest land Sa1e of a portion of a parcel of forest land subiect to taxation under this sub(hapter shall not affect the taxation unde~ this subchapter of the resulting paz cels unless they are less than 10 acres in area. Each resulting parcel shall be taxed to the owners under this subchapter until such parcel is withdras~'n from taxation under this. sub- chapter, in which case the penalties provided for in sections 579 and' 581 shall apply only to the owner of such parcel. If a parcel resulting from such sale is less than 10 acres in area such parcel shall be considered as withdrawn from ta-cation under this subchapter' as a result of such sale. Sec. 581-B. Reclassification and withdrawal in unorganized territory In the case of reclassification or withdrawal of forest land in the unorganized territory, the State Tax Assessor shall make such supplementary assessments or abatements as may be necessary to carry out this subchapter. Sec. 582. Appeal from State Tax Assessor 1. Petition for reconsideration. Any person aggrieved by any order of the State Tax Assessor under section 576 may petition him for reconsideration of that order within 30 days of the issuance of that order. If a petition. for reconsideration is filed within said period, the State Tax Assessor shall reconsider the matter and if petitioner has so requested in his petition, shall grant said petitioner an oral hearing, shall provide for -6- PAGENO="0591" 577 a transcript thereof and shall give the. petitioner at least 15 days' notice of the time and place thereof. For cause shown, the State Tax Assessor may extend the time for filing of such petition. The State Tax Assessor may amend of reaffirm his orders or determinations as he sees fit and may order a refund in whole or in part of any taxes, costs, penalties or interest thereon which have been erroneously or unjustly paid since the changed rates ni' values. In the event of any change in rates or values, the rates or values as so change shall remain in effect until the next review period. If the State Tax Assessor fails togive written notice of his decision within 90 days of the tiling of a petition for reconsideration, the petition shall be deemed to have been denied, and the petitioner may appeal as provided, unless the petitioner shall in, writing have consented to further delay. 2. Appeal to Superior Court. Any person aggrieved by the decision upon such petition may, within :io days after notice thereof from the State Tax Assessor, or after the petition shall be deemed to have been denied, appeal therefrom to the Superior Court in the county where the land orany part of the land is located. Notice of the appeal shall be ordered by the court and trialshall be held without jury in the manner and with the rights provided by law in other civil actions so heard. The proceedings shall not be de riovo. The court shall receive into evidence true copies of the transcript of the hearing, the transcript of the reconsideration hearing if further evidence was offered, the exhibits thereto and the decision of the assessor. The court's review shall be limited to question of law and to whether the assessor acted regularly and within the scope of his authority and the assessor's decision shall be final, so long as sup- ported by substantial evidence. The court may enter a judgment affirming of nullifying such order in whole or in part, or remanding the cause to the State Tax Assessor upon such terms as the court may direct~ and the court may order the refund, in whole or in part, of any taxes,~costs, penamesoi~Thterest Thereon which have been erroneously or unjustly paid since the changed rates or values. In the event of any change in rates or values on a~eal, the rates or values as so changed shall remain in effect until the review period. An appeal may be taken to the law court as in other actions. 3. Other persons affected. The State Tax Assessor or court, as the case may be, upon receiving a petition for reconsideration or an appeal, shall give public notice of said proceeding by publication for 3 successive days in a newspaper of daily circulation in the county or counties affected and may give such further public notice as the State Tax Assessor or court determines reasonable. Any person who may be aggrieved as a result of such a hearing shall be entitled to appear at the hearing arid enjoy the same rights to a hearing before the State Tax Assessor or court as the person filing the petition or the appeal. 4. Persons aggrieved. A person aggrieved hereunder shall be any person with a legal interest in land subject to the determination, any municipality in which land suoject to the determination lies, and the Attorney General of the State of Maine upon the written petition of 10 residents of the State of Maine if he shall see fit to intervene or appeal, in which event the ~ttorney General shall be authorized to employ In~ dependent counsel to represent such petitioners if he deems it appropriate to do so. Sec. 583. Appeal from assessor 1. Petition for reconsideration. Any person aggrieved by any determination by an assessor, other than orders pursuant to section 576, under this subchapter, may petition for a reconsideration of that determination within 30 days after being notified of that determination. If a petition for reconsideration is filed within said period, the assessor shall reconsider the matter and, if petitioner has so requested in his petition, shall grant said petitioner an oral hearing and shall give the petitioner at least 15 hotice of the time and place thereof. For cause shown, the assessor may extend the time and filing of such petition. The assessor may amend or reaffirm his deter- mination as he sees fit and may order a refund, in whole or in part. of any taxes, costs, penalties or interest thereon which have been erroneously or unjustly paid. If the assessor fails to give written notice of his decision within 90 days of the filing of a petition for reconsideration, the petition shall be deemed to have been denied, and the applicant may appeal as provided, unless the applicant shall in writing have con~ sented to further delay. -7- PAGENO="0592" 578 2 Appeal to Forestry Appeal Board Any person aggrieved by the decision of a muniupal assessor upon such petition may within 30 days after notice thereof from the municipal assessor or after the petit on shall be deemed to have been denied appeal therefrom to the F orestry Appeal Board established by section 565 and the F orestry Appeal Board may amend or reaffirm such determinations as the board sees fit and may order a refund in whole or in part of any taxes costs penalties or interest thereon ~hu~li have been erroneously or uniustlypaid which amounts shall be paid out of the municipal treasury if there are funds available a'~id if not payment shall be made in the following tax year If the Forestry Appeal Boaid fails to give ~ritten notice of its decision within 90 days of the filing of such an appeal the appeal shall be deemed to have been denied and the applicant may appeal as provided unless the applicant shall in `~ riting have consented to furtl~er delay Toe application to the Forestry Appeal Board shall be filed with the Forest Commissioner with a copy to the assessors of the municipality concerned and shall include the name and ad di ess of the Forestry Appeal Board member selected by the applicant Section 843 B shall apply to such proceedings 3 Appeal to Superior Court The applicant may appealf om the decision of the State Tax Assessor under subsection 1 or 01 the Forestry Appeal Board under subsectior~ 2 to the Superior Court in the county where the land or any part of the land is located The ajplicant shall when such appeal is taken file an affidavit stating his reasons for appeal and serve a copy thereof on the assessor and in the hearing of the appeal shall be confined to the reasons of appeal set forth in such affidavit Jurisdiction is granted to hear and determine such appeals and to enter such order and decrees as the nature of the case may require The decision upon all questions of fact shall be denovo and shall be final An appeal may b~ taken to the law en t't as in all other actions Decisions shall be certified forthwith by the clerk of courts to the assessor Sec a84 Advisory Council There is established a Forest Land Valuation Advisory Council, hereinafter called the Advisory Council which shall ~nnsist of the State Forest Commissioner ex officio aiid I members serving staggered 4 year terms to be appointed by the Governor with the advice and consent of the Council One of these members shall be a municipal officer one shall be a forest landowner and one shall be a member of the general public who shall have a background in economics The initial appointment of a mun~ ipal officer shall be for a 2 year period the initial appointment of a forest landowner shall be for a 3 year period the initial appointment of a member of the general public shall be for a 4 year period Thereafter said appointees shall be ap pointed to serve 4year terms and, in the event of the death or resignation of such an appointee the Governor shall make an appointment to the Advisors Council with the advice and consent of the Council, for the unexpired term. The members of the Ad- visory Council shall receive no compensation for their services but said Advisory Council shall be allowed actual expenses not to exceed $2,000 for each fiscal year. The Advisory Council shall render to the State Tax Assessor information and advice concerning the administration of the Maine Tree Gro~th Tax Law The Advisory Council shall hold a regular meeting with the State Tax Assessor or his deputy in F ebruar~ of each year and special meetings at such other times and places within the `)tdtt is v~ould seem a'ivisable At the meeting held in February o( each year the Advisory Council may elect one of its members as chairman arid on~i as vIce- chairman `e. a84 A Construction This subchapter shall be broadly construed to achieve its purpose The invalidity of pi o~ ision ~,hall be deemcd not to affect the validity of other provisions 8 PAGENO="0593" 579 Bureau of Property Taxation Room 202 State Office Building Augusta, Maine 04330 THE MAINE TRNE GROW2H TAX LAW GENERAL INFOBMATION (Title 36, N.R.S.A., Section 571 through 584-A, as enacted by Chapter 616, Section 8, P.L. 1971; as amended by Chapter 308, Sections 1 through 18; Chap- ter 536, Section 22; Chapter 592, Section 6; Chapter 645, Section 2, P.1. 1973) NOTE: This bulletin is intended only Lo give a general description of the principal features of the Tree Growth Tax Law, and to answer the questions that the average landowner is most likely to have. It is not to be con- sidered as a substitute for the law itself, copies of which can be obtained on request. Nor is it intended to answer technical questions as to application of the law, which should be directe4 to the Bureau of Property Taxa- tion, Room 202, State Office Building, Augusta, Maine 04330. The Maine Tree Growth Tax Law is a law which establishes a methodology for the current use valuation of classified forest land. It was enacted by Chapter 616, Section 8, Public Laws of 1971 in response to a 1970 amendment to the Maine Constitution which permits a current use valuation for forest, farm and open space lands. The law was subsequently amended by Chapter 308, Section 1 through 18, Public Laws of 1973. The amendments were intended to resolve various ambiguities, omissior~s and to provide needed clarification. The valuation approach specified by the law first applied to classified forest land on April 1, 1973. For April 1, 1974 and subsequent years, clas- sified forest land is to be valued on the basis of State certified values, by county, for softwood, mixed wood and hardwood forest land. In determin- ing the assessed value of the forest land the assessor is to adjust the State certified values by the local assessment ratio.~, A hypothetical example is one acre of classified softwood land located in a county with a certified value for softwood land of $30/acre. If this were in a municipality with a prevailing assessment ratio of 50% the assessed value would be $15 ($30 X .5). In establishing the certified values the State Director of Property Tax- ation redetennines growth rates every 10 years and stumpage values every- two years. In the spring of 1974 both growth rates and stumpage values will be determined. The certified value is derived by capitalizing the value of the annual net wood production. Under the law "forest land" is land used primarily for growth of trees and forest products. Parcels of land with more than 500 forest land acres are subject to mandatory classification while parcels with between 10 and 500 forest land acres can be classified if the owner makes proper application. A landowner can request classification by filing a Tree Growth Tax Law schedule and forest type map with the local assessor on or before November 1 of the year preceding that in which classification is to be effective. In 68-872 0 - 76 - 38 PAGENO="0594" 580 the case of a landowner who acquires sufficient land to constitute a parcel containing over 500 forest land acres, he should submit a schedule on or before the next No~'ember 1 to be considered in the mandatory classification of the parcel on the following April 1. If land which has been classified as forest land ceases to be uaed pri-.. manly for growth of trees and forest products, the classification may be withdrawn, either at the request of the landowner or on the initiative of the assessor. When such withdrawal occurs, the landowner becomes subject to a penalty based upon the tax advantage gained by classification, or a per- centage of the difference between fair market value and tax valuation at the date of withdrawal, whichever is greater. The law permits the lando~ner to appeal from determinations of value by the State Director of Property Taxation, as well as from forest type classi- fication by all assessors. The following questions and answers may assist in explaining the pro- visions of this law: 1. Is my land e1i~le. for taxation under the Tree Growth Tax Law? If your land is used primarily for the growth of' trees and, forest products, and if it is a parcel consisting of over 500 forest land acres, it must be so taxed. If your land is a parcel of le(ss than 500 forest land acres, but not less than 10 forest land, acres, you may request that it be classified and taxed under this law. If your land is made up of several separate parcels, none of which exceeds 500 forest land acres, you must request classification if you wish your land taxed under this law, even though your total holdings exceed 500 forest land acres. 2. j~ow do I request classification? If your land is to be taxed under this law next year, you must file on or before November lof the year pre- ceding that in which such classification is to apply with the assessors of the municipality in which your land is located (or the State Director of Property Taxation if your land is in unorganized territory) a signed schedule, identifying the land, a forest type map showing the location and acreage of each forest type (that is, hardwood type, softwood type and mixed wood type), and stating that the land is used primarily for the growth. of forest products. Such a schedule must be filed even though your land is a parcel of over 500 forest land acres in size. 3. Where do I obtain the necess~L schedules? The schedules are available from the State Bureau of Property Taxation and municipal assessors. 4. How do I determine the "forest, ~yp&'? "Hardwood type" is forest land on which hardwoods make up 75~For more of the stocking; "softwood type" is forest land on which softwoods make up 75% or more of the stocking; and "mixed wood type" is forest land on which neither hardwoods nor softwoods make up 75% of the stocking. 5. Can assessors refuse to c1assif~y land as ~o~st land? Yes, if they find that it is not. used primarily for the growth of forest products. PAGENO="0595" 581 6. C! asse!so~ chan~e nty~ breakdown as t~~es~ Yes, if they find the breakdown as shown on the schedule you filed to be incorrect. Assessors with whom you filed your schedule must notify you. on or before Narch 1 of the year in which classification would first apply, of their classification of your land as to forest type; otherwise they are deemed to have denied your right to have your land taxed under this law, 7. Can I appeal the rei'usalof assessors to classify rr~y land, or their clas sification a~ to forest type'? Y~s If your land is in unorganized territory you must request reconsideration within 30 days after notice of classification or refusal to classify (or within 30 days after March 1, if notice is not given); and you may further appeal to the Superior Court within 30 days of the decision on reconsideration, if you are still dissatisfied. If your land is in a municipality you must petItion the local assessors for reconsideration on the same basis as noted above; but in municipalities you may make a further appeal to the Forestry Appeal Board, and finally, to the Superior Court. 8. ~ is classified as forest land,~how will it be taxed? It will be taxed at the same rate as all other fand; b~it the val~ation will be based upon the capitalized value of the annual net wood production per acre for the forest type in the county in which the land is located, rather than upon market value. 9. How is the valuation of classifie4~prest land determined? Seventy per- cent of the average annual growth rate per acre for the forest type for the county in which the land is located, is multiplied by the average stuxnpage value for that forest type for that county, and the resulting value of annual net wood production per acre for that forest type and county is then capital- ized at a 10% rate to obtain the valuation per acre. 10. ~h determin~!,~1 ati~p~ The State Director of Property Taxation is directed to determine average annual growth rates on the basis of U.S. Forest Service Surveys, and average stumpage values on the basis of stumpage sales. These rates and values, and the resulting valuations, will be reviewed at one or more public hearings, and will be certified to the Secretary of State and filed in the State Bureau ci' Property Taxation on or before June 1, 1974, and biennially thereafter. 11. Is the valuation redetenained each veer? Growth rates will be determined in 1974, and ~i~}i~ 10 years thereafter. Stuxnpage values will be determined in 1974, and each two years thereafter. The capitalization rate of 10% is fixed by statute. Thus, the valuations will be redeterminei each two years. 12. How can I appeal from the valuation? If you are dissatisfied with the average annual growth rates or stunipage values as determined by the State Director of Property Taxation you may request reconsideration within 30 days after such rates or values are certified and filed; and you may further appeal to the Superior Court within 30 days of notice of the decision on reconsider'- ation, if you are still dissatisfied. PAGENO="0596" 582 ~4hile you can appeal from the local assessors' classification of forest land (see 7, above), you cannot appeal from your local assessment on the basis of the valuation per acre certified by the State Director of Property Taxation to the local assessors, since the local assessors ~ use the valuations so certified, (adjusted to reflect the local assessment ratio). 13. Must I request classification of n~r land each year? No. Once land is classified as f~~t land it remains so classified until you notify the as- sessor that it no longer is being used primarily for the growth of forest pro-. duects, or until the assessors find that it no longer meets the requirements of the law. In either event, it is then declassified (that is, withdrawn from classification), and thereafter is taxable on the same basis as other land. ll~. Is there an~penaltyif my landis put to other uses? If your land has been ciásified and taxed as forest land, and if it is later declassified because it no longer meets the requirements of the law, a penalty will be as- sessed. This penalty is the greater of: the difference between taxes actually paid under classification afld the taxes which would otherwise have been assessed, for a maximum of 5 years; or a percentage of the difference between the valuation of the classified land and the fair market value at the time of declassification (i.e., 10% through 1978, 20% from 1978 through 1983, and 30% thereafter). If your land is classified you are required to report to the assessor any change of use, and if you fail to do so, 25% will be added to the above penalty. 15. If I do not~~~ for classification this y~r~canIappl~nert ~ Yes. You can apply this year, or in any subsequent year, provided you do so on or before November 1 of the year in question. 16. If ray land had been stripped~ ~d_ seek classificatinn~llmy~andbe valued as if it was fully stocked? Generally speaking, all forest land of a given type in a county will be valued at the same amount per acre, regardless of actual stocking. However, if your land was forest land on January 1, 1972 and did not contain more than 3 cords per acre of merchantable wood, as certi- fied by the State Service Forester, the valuation is to be reduced by 50% until April 1, l98~3. In any instance where, after January 1, 1972 the trees are des- troyed by fire, disease, insect infestation or other natural disaster the valua- tion is to be reduced by 75% for a ten-year period. These are the only exceptions to the application of the average valuation. In these cases, the landowner must file an affidavit with the assessor on or before January 1 of the tax year to obtain the reduced valuation. 17. ~`1here can I obtain further information on the Tree Growth Tax Law? Copies of the Tree Growth Tax Law, arid answers to any other specific questio~ can be obtained by writing to the Bureau of Property Taxation, Room 202, State Office Building, Augusta, Maine 04330. PT-77A 6/20/72 (Rev. 4/74) 1,000W PAGENO="0597" 583 Mr. STErnER. Thank you very much. Mr. CONABLE. I would like to ask Mr. Weliman a question about the forestry industry. You stressed that 60 percent of timber is owned by small individual owners. Of course estate tax is not much of a ~roblem unless that percentage of ownership is the fact. I am a little skeptical about what you told Mr. Steiger simply be.. cause I know what the farmers up my way do. They have a woodlot somewhere and maybe the price of timber goes up and some sharp eyed, bushy tailed fellow comes through and says, "Say, you have a pretty good stand of hard maple out there, let me give you a deal on it, and I will do all the expensive work." And the guy says, "Why not? Here is a nice little cash crop I can add." I don't think he is in the business, but it is something folks like to do, and their asset has just happened, out there in the wood lot. It has not been anything he planned on. But what I would like to ask is, is this the pattern of ownership generally throughout the United States? Quite obviously in the West you are going to have a lot of government lands, and a lot of cor- porate lands, but is this pattern a fairly general one, this 60 per- cent? I know Mr. Towell referred to it also. Or is it very much concen- trated in a few parts of the country? Mr. TOWELL. I think I can answer that for you, Mr. Conable. In the South that figure goes up to 70 percent, a little over 70 per- cent, and here in the eastern part of the country it is higher than the nationwide average of 59 percent. Because as you pointed out in the West you have a lot of government ownership as well as large corporate ownerships, but the pattern you describe is not an uncom- mon one. People have this land, and the timber is accidental pretty much, and something comes along and it is too easy to go ahead and liquidate. Mr. CONABLE. Widely fluctuating timber values too~ Mr. Towi~r~. That is right. Mr. CONABLE. And access to market is an important issue. Mr. TowEu~. It certainly is. Marketability and access to the timber. But we have trying to overcome this through technical assistance. This is one of the obstacles to this private forest land management in addition to taxation. That is having the professional forestry as- sistants to draw up a management plan that has been referred to here and to get this on record for an objective in management. The Forestry Incentive Act is one good example of trying to get some- thing done in this direction. Every State has a forestry program to aid the small landowner. Mr. CONABLE. I was just trying to determine to what extent that was a general condition you were describing in the industry, and, to what extent it was regionalized, or localized to the point where you would not have- Mr. TowEu4. These lands are sorely in need of help. They are pro- ducing between one-third and one-half of their capability. I think I indicated that before. Mr. VANIK. I would like to ask how many so-called family farms are there that are involved in timber? How many families? Mr. TOWELL. Over 4 million individual ownerships. PAGENO="0598" 584 Mr. VANIK. Does that exclude the subsection S group? Mr. TOWELL. It excludes commercial ownerships and large owner- ships formally defined as over 5,000 acres. Mr VANIK How many of these estates have applied in Treasury for deferral ~ Mr TOWELL I can't answer that Mr VANIK Could you give us any figures as to how many for estry operations were sold last year in order to pay estate taxes ~ Do you have a figure on that ~ Mr TOWELL Not forestry operations A large number of individual private woodlots had to be sold either to pay-the timber had to be sold or the lands had to be sold. Mr. VANIK. We would like to have some figures on what was sold in order to meet the tax problem rather than demands of estate dis- tribution. I think we should separate the pressure for estate distribu- tion from the tax question I would like to know specifically how many sales were directly re lated to the tax problem, because that is what we are talking about I would like to have the same response with respect to quarries from the limestone industry Now, you can't tell how many estates applied for deferral I think we can probably check that with Treasury. How would you feel about limiting any increased exemption or other special provisions in the tax to the so called small farms as they were defined in the Reform Act of 1975 ~ Mr TOWELL I don't know how it was defined Mr VANIK That provided that 66 2/3 of the voting stock plus 66 2/3 of total stock would be owned by a single family Mr TOWELL I think what we are talking about should be applied Mr. VANIK. That would provide the relief. Mr. WELLMAN. That would be in a corporation? Mr. VANIK. Yes. In other words, two-thirds. Mr. WELLMAN. My testimony was addressed to outright fee owner- ship, not corporation. Mr. VANIK. You did not concern yourself with those families that incorporated? Mr WELLMAN This is not a common practice in our area Mr VANIK So as far as you are concerned if we did not do any thing about corporations, the relief is solely for individuals. It would take care of most of your problem Mr. WELLMAN. It would take care of most of us in Maine, and New England, but there would be other parts of the country that might feel differently. Mr. VANIK. What is the average holding time on timber? It varies according `to the crop, doesn't it? Mr. TOWELL. Average between 20 and 30 years. Mr. VANIK. So you cross the generation simply in the holding of the timber. I think you are in a special situation because of the nature of your industry, `because it does hold over quite obviously from one generation to the next. Thank you very `much. The CHAIRMAN Are theie further questions ~ PAGENO="0599" 585 Mr. Waggonner. Mr. WA000NNER. Thank you, Mr. Chairman. I would like to pursue for just a moment an area that Mr. Vanik touched on. I think as I understand this situation with regard to forestry products as it affects these small tree farmers stems from the fact that we are dealing basically with people who are 50 and over. They own a majority of the independent tree farms. We are looking at the situation where in more than half of the timber grown on these farms will be involved in estate tax transactions in the next 10 to 15 years. We are really looking at something worse down the road than we are at this point in time. This really makes Mr. Vanik's request for figures about how much acreage was sold last year useless because of the estate tax problem. What you have got is a growing situation that is going to get worse in the years to come. Do I misunderstand that? Mr. WELLMAN. No, sir. You are quite right. We arc concerned about what are the incentives for the owner in the age bracket you mentioned to practice and implement by spending capital those for- estiy practices which will cause to be available at that future date, a harvestable crop. Mr. WAGGONNER. One of the statements-I was not here when it was made-but one of the statements in behalf of the committee-on page 9 you dealt with the deferred estate tax payment rules. You said that you basically endorse the President's proposal to relieve the executor of liability where the estate tax is paid over a period of up to 10 years. Mr. WELLMAN. For the asset that we are talking about, yes, sii~. Mr. WAGGONNER. It seems to me this is something that you touched on that others have not until this point touched on which is extremely important. Mr. VANuc. `Will the gentleman yield? Mr. WAGGONNER. In just a second. If we don't have that relief and if you have a situation wherein postpone payment of the estate tax for a 20 year period and that sort of thing, really you have not accomplished much. I will be happy to yield. Mr. VANIK. I would suggest if we were to relieve the executor of that responsibility that it should not be an executor who is also a beneficiary. In other words, the authority is one `who stands in a clear trust relationship. Mr. WAGGONNER. I do&t think anybody is talking about an executor who is a beneficiary. We are just talking about somebody who is serving as the executor. Would one of you care to describe for me now what you think would be workable, fair, and equitable to the extent that it is possible, with regard to valuaition for estate tax purposes, of nonmarketable timber or timber that is the growing stage and is not yet being mar- keted, because it seems to me is an excellent example of contrasting fair market value. You could go out there and clear cut 500 acres. You could strip it. You could get every peimny there is for the timber and that is a fair market value. PAGENO="0600" 586 But I am trying to point out that sometimes you have to equate fair market value with good forestry practice, and other long-term concerns. Could you comnient a little further there? Mr. POWELL. I would like to comment on that. If you don't have my testimony before you, I will submit it to you later. It is obvious that most appraisals today relate very little to the actual management practice of the land. The practic1e really relates to the investment speculation that is taking place in the area at the time for perhaps similar lands. They may not actually be similar, but they are similar at least in location. If there is good timber on the land, the timber value may be added to the speculative value of the land. This creates problems in several ways. First, it gives a value which is much higher than the value that would be analyzed from an income cash analysis, discounting the flow of income back to present value. It also creates an estate tax problem because of the other things we are mentioning here; for instance, that it sometimes takes 60 or 70 years to grow a stand of timber to maturi- ty, causing an individual tree to be taxed as many as three times as it is standing there growing. I mentioned in my testimony a moment ago that to be able to main- tain a productive forest, we are going to have to have a timber base. We are only harvesting a very small percentage of the timber peri- odically. We are establishing new stands periodically; but to be able to maintain productivity in timberland, we have to protect a timber base. And, of course, this timber base is being constantly appraised and taxed. In addition to the State and county taxes, for ad valorem pur- poses the income is taxed for income revenues; and we are taxing the timber base several times for estate taxes within a single timber rotation. [The following was supplied for the record:] STEPTOE & JOHNSON, ATTORNEYS AT LAW, Washington, D.C. March 26, 1976. Mr. JOHN M. MARTIN, JR., Chief Counsel, Committee on Ways and Means, Longworth House Office Building, Washington, D.C. DEAR JOHN: During the course of discussions on Estate and Gift Taxation on March 16 before the Ways and Means Committee, Congressman Vanik asked certain questions of Mr. Wellman and Mr. Powell dealing with the number of timber estates where executors have asked for an extension of time for payment of estate taxes under Section 6166, the provision providing relief for estates consisting largely of interest in closely held businesses. Mr. Weliman asked me to amplify the record on this point with your per- mission. We understand that Mr. Vanik may request the Treasury to give him in- formation on the actual number of requests under Section 6166. However, regarding the general applicability of that section of timber estates, our wit- nesses wished to point out that the definition of "closely held business" in that section may not apply to timber owners under many circumstances. For example, where the owner is a long term investor in timber and has not made cuttings for several years, agents may not be willing to consider the timber ownership a trade or business. PAGENO="0601" 587 Inasmuch as the section is often not applicable to timber owenrships, the actual number of requests by executors for extension of time for payment under the section may not be as meaningful as it might otherwise be. If we can be of further assistance, please let me know. Sincerely, WILLIAM K. CONDRELL. The CHAIRMAN. Are there further questions? If not, thank you very much. We appreciate your testimony. Our next panel of witnesses consists of representatives of the Na- tional Livestock Tax Committee; the American National Cattlemen's Association, National Livestock Feeders Association; and National Wood Growers Association, Claude M. Maer, Jr.; Gerard M. Bran-. non, Georgetown University; Independent Cattlemen's Association of Texas, T. A. Cunningham, President; and Florida Cattlemen's As- sociation, Airic Pottberg. If you will be seated in the order I mentioned from this end, we will be glad to put up your names. Mr. PICKLE. Mr. Chairman, I want to welcome Mr. Cunningham. He is not from my district, but his office is in the State capital, and I feel like he is from my district. I know he will give interesting testi- mony because I have known him and particularly his young son well and favorably. I welcome him to the committee. A PANEL CONSISTING OP E. H. SHOEMAKER, JR., NATIONAL LIVE- STOCK TAX COMMITTEE AND AMERICAN NATIONAL CATTLE- MEN'S ASSOCIATION; GERARD M. BRANNON, GEORGETOWN UNIVERSITY; SAMUEL P. GUYTON, COUNSEL TO NATIONAL LIVESTOCK TAX COMMITTEE, AMERICAN NATIONAL CATTLE- MEN'S ASSOCIATION, NATIONAL LIVESTOCK FEEDERS ASSOCIA- TION, AND NATIONAL WOOL GROWERS ASSOCIATION; T. A. CUNNINGHAM, PRESIDENT, INDEPENDENT CATTLEMEN'S ASSO- CIATION OF TEXAS; B. H. (BILL) JONES, NATIONAL LIVESTOCK FEEDERS ASSOCIATION; ALRIC POTTBERG, FLORIDA CATTLE- MEN'S ASSOCIATION; AND JAMES L. POWELL, NATIONAL WOOL GROWERS ASSOCIATION STATEMENT OF E. H. SHOEMAKER, JR. Mr. SHOEMAKER. Mr. Chairman and members of the committee, I am E. H. Shoemaker from Nebraska, representing the National Live- stock Tax Committee, and also The American National Cattlemen's Association. I have with me Mr. James Powell of Texas, representing the National Wool Growers Association, and Mr. Bill Jones from Nebraska, representing the National Livestock Feeders Association, together with Mr. Samuel Guyton, from Holland & Hart in Denver The CHAIRMAN. Mr. Shoemaker, will you speak for the other mem- bers, on their behalf? Mr. SHOEMAKER. Yes. We appreciate this opportunity to appear, and in the interest of conserving time a written joint statement with summary has been presented for members of the committee. The CHAIRMAN. Without objection the full statement and supple- PAGENO="0602" 588 mental material will be included in the recoid and you may proceed to summarize Mr SHOEMAKER Ihe number one issue facing agricultuie and the livestock industry in particulai is the impact of our present outdated Federal estate and gift tax laws causing insurmountable financial problems foi those of us engaged in farming and ranching These problems include inflated high valuations for estate tax purposes, and lack of liquidity due to the limited cash flow caused by ever increas- ing operational costs and capital expense costs. Remedial legislation is needed allowing property valuation for estate taxes based upon productivity to assure continuity of farm and ranch units Consideiation of the seiiousness of the problem should be recognized with a minimum $100,000 marital deduction together with a $200,000 exemption for purposes of the Federal estate tax Annual exclusions applying to gifts should also be increased having remained static foi so many years The resulting breakup of estate lands in agricultural production due to lack of liquidity assures fewer qualified and experienced people engaged in farming and ranching to produce abundant food efficiently. I am sure that the Congress does not wish to see the confiscatory estate tax continue such as we have now. This completes my portion of the opening rernaiks, and I would like to call upon Mr Samuel Guyton of Holland and Hart to make a few comments STATEMENT OP SAMUEL P GUYTON Mr GUYTON Mr Chairman, my firm in Denver, Cob, is legal counsel to these organizations. One of the most difficult problems that the farming and ranch com- munity is facing today is the devastating effect that the Federal estate tax is having on farms and ranches Our study showed that the I~ ed eral estate tax is causing forced liquidation of many farms and ranches as they are passed down from one generation to another This has two principal adverse effects The first is it threatens the existence and continuation of the family farming ranch as a viable economic unit The second is it impedes the ability of farms and ranches to produce essential food and fiber needed by the consuming public at reasonable prices. Dr. John Hopkin, who is an economics professor at Texas A. &M., speaking on this problem, said, "Society is the loser when an efficient productive farm and ranch must be liquidated every generation." The problem causing the forced liquidations of farms and ranches is based on two aspects First is the valuation approach under our present Federal estate tax laws under which revenue agents value farm and ranchlands based on what land will sell for for develop ment or speculation which is often very unrealistically high and has no relation at all on the ability the farm and ranch to produce profits Associated with this is the concomitant illiquidity of farm or ranch assets with the result that there is insufficient cash available to pay estate taxes within 9 months-or within any other period of time- after date of death, based on this fair market value criteria Farm and ranch estates pay these high taxes which are going higher and higher as Federal estate farm and ranch property values increase. What are the sources which can be used to pay these taxes ~ PAGENO="0603" 589 The first is from farm earnings. As we know from looking at farm earnings, the production costs in the industry now are frequently higher than the income from those assets. So farm earnings cannot be counted on to supply the funds. The second is from nonfarm assets, but most farm and ranches do not have sufficient nonfarm assets to pay the Federai estate tax. The third place farmers and ranchers look to pay Federal estate tax is by borrowing the money, but farm and ranch indebtedness is already at record levels. Many farms `and ranches are mortgaged to the hilt and cannot borrow enough money to pay the tax. That leaves the fourth alternative. That is to sell part or all of the farm or ranchiand to pay Federal estate taxes. This is what has caused the problem. Our organization feels there is a solution to this, and what we have to look to is the cause of the problem. Going back again to `the very high valuations. We feel legislation such as that introduced by Congressman Burleson and others of this committee recognize this very important problem and would permit the executor of a farm and ranch estate to value the farm or ranch based on productive capacity. Since farms or ranches are operated in various forms we feel a value `based on earnings should apply whether the farm is operated as a proprietorship, partnership, or corporation, and should apply to all farm and ranchland used in the trade or business. We feel, however, that one particular feature should be incor- porate'd in the statute. That is the valuation formula. And this we feel can best be accomplished by using rental income, and many have discussed' this which is covered in detail in our `written statement. Based on rental income we feel a capitalization factor can be ap- plied to arrive at a very soun'd and reasonable Federal estate tax value for farm and ranchlands. Our ranohland appraisers are accus- tomed to this approach, and we feel it can `be `done without any problems. So, we feel the most urgently and immediately needed legislation in this area is on the valuation o'f farm and ranch lands for Federal estate tax purposes. We do, also, support increasing the Federal estate tax exemption for all estates, not just for farms a'nd ranches, but for all estates, from $60,000 to $200,000 to reflect the effects of inflation since 1942 when this amount was established. We further support `th'e increase in marital deduction to provide a floor of $100,000 for property passing to a surviving spouse. And speaking of surviving spouses, we want to make one important point here. In many common law States where farm `and ranch land is owned by a husband `and wife in joint names, when the husband dies first-which is normally the case-under present Federal estate tax laws the full value of the farm or ranohland is included in his estate and no value is attributable to the hard work the wife has put into that farm and ranehland. We feel Federal estate tax laws should be amended to recognize the hard work and contribution that a farm and ranch wife puts into `the ranchland because often the farm and ranch wife works as hard or PAGENO="0604" 590 even harder than her husband to improve and create the value of the properties. We also support increasing the Federal gift tax annual exclusion and lifetime exemption to reflect the effect of inflation since these amounts were established in 1942. Having said those items for which we give support, let me briefly point out two items we are opposed to. We are opposed to the pro- posal to tax capital gains at death as it applies to farm and ranches. Farm and ranch estates cannot presently pay Federal estate tax without having to face the specter of a forced liquidation every gen- eration, so it is not possible to pay the added on capital gains tax at death. Attached to our written statement is an exhibit which clearly demonstrates this using one of the most productive ranch examples in all of this country. Further we feel capital gains tax at death treats death as a sale of the property, but yet death is not a sale, and there is no cash gen- erated with which to pay this tax. The lock-in problem, that is, that under present law capital gains escape tax at death so that elderly owners of appreciated property tend to hold on rather than to sell before death, does not apply to farm and ranch assets. This is because a ranch is held as an operating unit not to be bought and sold like a portfolio of stocks. The second opposition we have is to the alternative proposal to have a carryover basis into the hands of the heirs. We feel this would be difficult to administer and very difficult to comply with. We think also that we should start with a. clean slate at death and many of us who have worked on farms and ranch estates as part of our livelihood know it is very difficult even now, when gifts are made, to determine what the basis of the donor is. We think it would be increasingly difficult if we applied this after date of death. Of course such an alternative would be a boon to tax lawyers, but we don't think this should be an expense added on those. other costs to farm and ranch estates. So in closing we would say we feel remedial legislation is needed. The most urgent need is that the evaluation of farm and ranch lands be based on productive capacity and not on selling price. The CHAIRMAN. Have you covered the entire spokesmen of the group? Mr. SHOEMAKER. Yes, this concludes our presentation. [The prepared statement and attachments follow:] STATEMENT OF NATIONAL LIVESTOCK TAX COMMITTEE; AMERICAN NATIONAL CATTLE- MEN'S ASSOCIATION; NATIONAL LIVESTOCK FEEDERS ASSOCIATION; AND NATIONAL WOOL GROWERS ASSOCIATION SUMMARY The existence and continuation of farm and ranch operations are seriously threatened by the federal estate tax. This is the result of unreasonably high valuations placed on farm and ranch land by Revenue Agents and the basic illiquidity of farm and ranch assets to pay the federal estate tax. An additional problem is caused by the failure in administering present federal estate tax to recognize the value of a wife's contribution to the value of farm and ranch property held in joint names by the farmer and his wife. Remedial legislation is urgently and immediately needed to correct these serious problems. The most pressing need is for legislation which would per- PAGENO="0605" 591 mit the federal estate tax valuation of farm and ranch land to be based upon such land's earning capacity or productivity for agricultural purposes. The federal estate `tax laws should also be amended to recognize the wife's con- tribution to the value of farm or ranch property held in the joint names of the farmer and his wife. Support is also given to the proposals to increase, for all estates, the federal estate tax exemption from $60,000 to $200,000 and to provide a minimum marital deduction of $100,000 for property passing to a surviving spouse. Increases in the federal gift tax annual exclusion and lifetime exemption to reflect inflation since such amounts were established are also needed. The proposal to tax capital gains at death, if enacted, would be the death knell for farm and ranch estates which are having extreme difficulty in pay- ing even the federal estate tax; such proposal would create problems in both compliance and administration and since equity is achieved by permitting the heirs of a decedent to claim a basis in inherited property based upon the federal estate tax value of such property. INTRODUCTION Formed in 1942, the National Livestock Tax Committee (NLTC) is spon- sored by a number of national, breed and state livestock associations through- out the country and has as its purpose maintaining and assuring equity and equality in the fields of federal income, gift and estate taxation for the entire livestock industry. Representing over 300,000 cattlemen throughout the nation, the American National Cattlemen's Association (ANCA) is a voluntary, nonprofit, non- political organiza.tion. The National Livestock Feeders Association (NLFA), a nonprofit, voluntary, nonpolitical organization, represents stockmen in over 200 state and local affiliated associations. The National Wool Growers Association (NWGA), a voluntary, nonprofit, nonpolitical organization, represents 22 state and regional organizations en- compassing a 25 state area, where 90% of the nation's lambs and wool are produced. NLTC, ANCA, NLFA, and NWGA speak for the entire red meat animal industry in the nation. In addition, NLTC represents dairy and horse organizations. In 1973, `as well as in prior years, representatives of NLTC and ANCA ap- peared jointly before this Committee to testify on the subject of estate and gift taxation as it affected farm and ranch operations. See Statement dated March 29, 1973. I. ESTATE TAXES-PROBLEMS OF VALUATION AND LACK OF LIQUIDITY IN ESTATES OF STOCKMEN AND INEQUITABLE TREATMENT OF SPOUSES In the area of federal estate taxes, there are `two serious problems, which are interrelated, facing the entire livestock industry. One problem concerns the present method employed to value Interests in farms and ranches for federal estate tax purposes and the second involves the inability of the estate of a decreased farmer or rancher to pay the federal estate tax levied against the estate because of the basic illiquidity of farm and ranch assets. A third problem relates to the unfair treatment meted out to a surviving spouse of a deceased farmer in common law states where, under present federal estate tax laws, the surviving spouse is presumed to have contributed no value to the farm or ranch, with the result that the value of the entire farm or ranch is included in the deceased farmer's estate. Unreasonably High Valuations of Farms and Ranches In recent years there has been an alarming upward trend in the valuation of farm and ranch properties for federal estate tax purposes. The result has been higher and higher estate taxes at death Thus, in turn, has forced the sale or liquidation of a number of substantial livestock operations, and threatens to force the liquidation of many farms and ranches whose owners may die in the future not owning sufficient nonf arm assets. In fact, according to a U.S. Depart- PAGENO="0606" 592 ment of Agriculture Study prepared by the Office of Planning and Evaluation in July 1975 entitled A~terna~tive Futures for U ~ Agrwulture A Progress Re port it is stated that one fourth of all farm real estate transfers are for the purpose of estate settlement Even the sale or liquidation of a part of the farm or ranch land in order to raise enough cash to pay these large federal estate taxes causes a fragmentation of the farm or ranch as an operating concern and results in the inability of many family farms and ranches to con- tinue to operate as an economic unit. In a statement presented at the Joint Hearing of the Select Committee on Small Business and the Joint Ec6nomic Committee of the United States Senate in Minneapolis Minnesota on August 26, 1975 on the subject of the Impact of Federal Estate and Gift Taxes on Small Businessmen and Farmers it was stated by Mr Louis Woehier that estate and inheritance taxes take approximately 28% of a 160 acre farm and approxi mately 32% of a 320 acre farm based upon 1975 farm land values in the State of Minnesota The effect of this trend is not only to threaten the continuation of the traditional family farm or ranch as a viable economic unit but it also portends a potential adverse effect on providing the essential food and fiber needs demanded by the consuming public. Referring to this serious problem, Dr. John A. Hopkin, an agricultural econo- mist at Texas A&M University, says that society is the loser when an efficient, productive farm unit must be liquidated every generation in order to pay the estate taxes which are imposed. See Exhibit A attached hereto. A continuation of this trend of causing the sale of farm and ranch land to pay estate taxes reduces the capability of agriculture to supply food and fiber to the public and could result in an increase in the price of agricultural pioducts Furthermore while it would seem prudent tax policy to encourage the retention of farm and ranch land for production of agricultural commodities, this policy is frustrated where such land is put to neqfarin uses by persons who purchase such land as a result of a forced sale caused by higher and higher estate taxes. Such non- farm uses include not only utilization of agriculturally productive land for housing and Industrial purposes but also application of such land to recreation al uses such as resorts hunting lodges and dude ranches Whatever the non farm use to which agricultural land is converted in these forced sale situations the end result Is the removal of needed land from agricultural production. The primary reason for this upward trend in the valuation of farms and ranches Is the requirement in the federal estate tax regulations that the estate tax be imposed on the "fair market value" of the assets owned by a decedent at the time of his death In the case of real estate Internal Revenue agents usually obtain a fair market value by a comparison of the land to be valued with the prices for which other land in the area has sold within a few years before or after the particular valuation date Revenue Agents frequently follow the practice of applying the highest recent sales prices of nearby land to the particu- lar farm or ranch being valued, even though such land was purchased for recreational, housing, Industrial or some other nonfarin use. More often than not, these prices are vastly inflated, are not truly comparable to the decedent's farm or ranch and bear no relationship whatsoever to the Income which the farm or ranch will produce A combination of the fragmentation of farm and ranch lands and sales of such lands at inflated prices has had an enormous influence on the federal estate tax values placed by Revenue Agents on larger tracts of such lands Thus Revenue Agents sometimes value a several thousand acre farm or ranch based upon the inflated price paid for a few acres of farm land by someone who is in the subdivision recreation or some other nonf arm business or activity In addition while the estate tax valuation of large holdings of a particular stock owned by a decedent may be discounted by application of the "blockage" rule, Revenue Agents will generally not permit the valuation of large tracts of farm or ranch land to be discounted by use of a comparable procedure. Furthermore, Revenue Agents frequently refuse to give any consideration to other pertinent factors such as the earning capacity of the farm or ranch or the degree of ownership represented by the interest in the farm or ranch being valued in determining estate tax values. PAGENO="0607" 593 Ecvamples of Valuations The following examples, taken from actual case histories, are illustrative of the acute problems caused by the present valuation practices utilized by Revenue Agents. Ea~ample A This example involves a rancher who owned and lived on a ranch all his life until he died a few years ago. Although the rancher had operated his ranch in an economical and sound manner, he had accumulated losses of approximately $360,600 during the period 8 years before his death, primarily because of cli- matic conditions and low cattle prices. He even had to borrow substantial amounts on his life insurance policies in order to cover his operating losses and to provide for his family. This ranch, located in the southwestern part of our country, was valued at $15 per acre on the federal estate tax return, resulting in a total estate tax of over $19,000. In auditing this return, the Revenue Agent contended that the ranch should have been valued at $32 per acre., resulting in an estate tax of over $80,000. No recent sales of comparable land in the vicinity had been made except for the sale of about 2,500 acres to an educational associ- ation for approximately $10 per acre. Four qualified appraisers stated that the valuation of this ranch could not exceed $16 per acre. As a result, considerable time was spent and costs incurred by the rancher's family before a settlement was reached on the per acre value of the ranch. Ewample B In this case, the executor valued the farm at $137,100 for federal estate tax purposes. When the Revenue Agent audited this return, he fixed the value of this farm at $1,061,370. This higher evaluation was based upon the purchase of a few acres by an industrial firm sometime after the farmer's death. This matter was litigated in a court proceeding at considerable expense to the estate, where it was held that the value of the farm for federal estate tax purposes was $265,000. Ecoample U This example involves an elderly rancher, whose average annual gross income for the past several years has been only about $4,000. Based upon this rancher's own estimation of the "fair market value" of his ranch, federal estate and state inheritance taxes would total almost $38,000, more than nine times the average gross income from the property. If a Revenue Agent placed a higher value on this ranch property, these taxes would be even greater. Ecoample D In this recent case, a rancher died whose ancestors had homesteaded the ranch property. On the Federal Estate Tax Return filed by the rancher's estate, a tax of $7,900 was shown and paid based upon ranch assets which were valued at $734~,000.' In auditing the return, a Revenue Agent Increased the valuation to over $1,260,000 resulting in the assessment of an additional tax of $30,240 over that which had already been paid. The years prior to the rancher's death the ranch had shown an average annual income of only $4,400. Unlike many ranchers' estates, thjs particular estate was fortunate enough to be able to borrow enough money to pay the assessed tax deficiency. Ultimately, through the filing of a claim for refund in Federal District Court, the estate was able to reduce the additional tax assessed from $30,240 t~ $19,000. However, substan- tial legal expenses were incurred In securing this reduction In the unreasonably high assessed tax deficiency. Eceample B In another case, the rancher's estate consisted of ranches located in several states. On the Federal Estate Tax Return one of the ranch properties had been valued at $393,000 based upon an independent appraiser's report; however, the Revenue Agent auditing the return increased the valuation to $720,000. This resulted in the federal estate tax, which was reflected on the estate tax return at $88,200, being increased to $126,200. Yet for a number of years preceding the decedent's death, the ranch had witnessed some profit years and some loss years, 1 Decedent's Interest was about 10% of this amount. PAGENO="0608" 594 which when averaged showed in the aggregate a profit of only $1,800 per year. As in other estates considerable expense was incurred in contesting the valua hon which ultimately resulted in substantial reduction of the assessed deficiency but still the rancher s estate was hard pressed to raise sufficient cash to pay the original tax plus the amount of the tax deficiency The foregoing examples underscore the problems facing the heirs of many farmers and ranchers in raising funds to pay federal estate taxes caused by these unreasonably high valuations Because of the very high valuations assessed by Revenue Agents against farms aiid ranches it Is evident that in most cases the heirs will not be able to pay the federal estate taxes out of operating income especially under present depressed economic conditions where farmers are selling their livestock for less than their total production ta2 Unless there are sufficient outside assets which is seldom the case the heirs will have to mortgage or sell all or a part of the farm or ranch property and livestock Because most farms and ranches are already heavily mortgaged it is frequently not possible to borrow enough money to pay the~se taxes Moreover the value of a farm or ranch is to a great extent based upon the entire tract and sale of a part will disproportionately reduce the value of the whole Some persons have alleged that these escalating farmland values are caused by the relatively few persons entering the farming and ranching business for tax profits as opposed to economic profits This allegation is referred by studies which show that the primary causes of the rapid appreciation in farmland values are: (1) limited amount of land; (2) use as an inflation hedge; (3) urban booms; (4) acquisition by federal, state and local governments; and (5) desire to be a part of agriculture 8 Lack of Liquidity-Inabthty to Pay Estate Tacees From Farm Earnings The second major problem facing the livestock industry in the federal estate tax area is the inability Gf the estate of a farmer or rancher to pay the estate tax out of earnings and keep the farm or ranch intact as an economic unit because of the illiquidity of farm and ranch land Reference is made to the discussion and analysis of this liquidity problem in Dr John A Hopkin s study which is attached hereto as Exhibit A This liquidity problem has also been iecognized by the U S Department of Agriculture in its 1973 report No AER 242 Increasing Impact of Federal Estate and Gift Tacoes on the Farm Sector Present Law and Proposed Changes Today the value placed on land and the price for which It might sell is all out of proportion to what it will earn The economic fact is that ranch and farm land is selling now for prices upon which it is frequently economically impossible for a farmer to earn a reasonable return Unfortunately even in the light of this economic fact many Revenue Agents refuse to give any considera tion whatsoever to the earning capacity of a farm or ranch Thus from the point of view of earnings there is a definite and serious discrimination in the estate tax field against farm and ranch land The result is the imposition of an estate tax based upon the fair market value of what is owned whereas the ability to pay the estate tax is based upon what the property can earn or what can be saved out of its earnings. Estate taxes can only be paid by (1) selling off part of the property which often will seriously impair the value of a working farm or ranch which usually took a lifetime to assemble or (2) from net Income and today s net income from farm and ranch property is very low in relation to market values This means that in many cases the family which does not have substantial outside assets just cannot pay the estate taxes and still continue to operate the farm or ranch intact as an economic unit and produce food and fiber needed by the public 2 Guidelines Volume I, February, 1975, published by American National Cattlemen's Association and Cattle Marketing Information Services Inc 8 It was reported In the Busine8s Beef Bulletin September 10 1971 published by the American National Cattlemen s Association based upon U S Department of Agriculture studies, that urban growth is usually made at the expense of farm and ranch land, that 80% of land used for subdivisions and industry is from the top three grades of farm and ranch land and that about 2 million acres of farm and ranch land are lost each year as follows: 1,000,000 acres to wilderness areas, parks and recreation areas; 420,000 acres to urban development; 420,000 acres to reservoirs and flood control; and 100,000 acres to airports and highways. PAGENO="0609" 595 This liquidity problem is perhaps more acute in agriculture than in any other industry because of the large investment in land and the nature of farming and ranching operations. Under present federal estate `tax laws, the tax must be paid, unless an exten- sion is granted, within 9 months after the farmer or rancher's death. This would place an insuperable burden on estates of farmers and ranchers to pay the `tax if it were not for the provisions in existing law which permit at least some relief by granting an extension of time to pay such tax. In many instances, the estate of a farmer or rancher will qualify under either the hardship rule or section 6166 of the 1954 Internal Revenue Code which authorizes the estate to pay the tax over a period of up to 10 years. Where an estate does not qualify for such extension, it still may be possible under the more liberal policy adopted by the Congress in 1971 for the estate to obtain an extension of up to 12 months to pay the tax. However, in many cases even the 10 year extension rule will not be of substantial benefit and assistance since the earnings from the farm or ranch are often insufficient to pay the annual installments after living expenses are taken out plus the 7% interest (as of February 1, 1976) charged on the unpaid amount. The increase in this interest rate from its 4% rate prior to July 1, 1975 will further contribute to the unattractiveness or inability of electing to pay the estate tax over a 10 year period. In addition, there are significant administrative burdens imposed by the Treasury Regulations on the estate of a farmer or rancher in operating the farm or ranch after the de- cedent's death in order to preserve the right to pay the estate tax over the 10 year period. Written reports are required to be made by the rancher's estate to the Internal Revenue Service of transactions regarding the farm or ranch opera- tion, which in essence causes the Internal Revenue Service to become involved in the farm or ranch business. For instance, certain withdrawals of funds from the ranch business or certain sales or dispositions of interests in the ranch must be reported and can cause acceleration of the payment of the estate tax. The Treasury Regulations also require the rancher's estate to apply all undis- tributed net income earned in the fourth and all subsequent yearn following the rancher's death to the payment of the remaining balance of the estate tax. Thus, while the 10 year extension of payment rule can be of value in some cases, the restrictions and limitations imposed by such rule on the operation of a farm or ranch and the increase in the interest rate on the unpaid balance of the tax can mitigate the intended benefit of paying the estate tax over a period of years. As one knowledgeable commentator has said, gra~ting~ additional time to pay estate taxes Is not a satisfactory solution to the problem if the taxes are so high that a sale of the business Is required. An associated problem result,s from the requiremen.t that the estate tax return must be filed within 9 months after date of death. Where an estate con- sists of securities or similar property, there Is frequently no problem in meeting this 9 month filing date. However, In the case of farm and ranch estates, It is often very difficult to meet this 9 month filing date because of the time required to gather all relevant data and to have the farm or ranch land appraised. This problem would be mitigated for farm and ranch estates If they were permitted to file the estate tax return within 15 months after date of death, as It was* under prior law. There exists today, as there has in the past, a severe cost-price squeeze caused by ever increasing costs which have far out distanced increases in prices.4 This squeeze has been partially compensated for by farmers becoming more efficient and by the paper profit Involved in the increase In farm and ranch real estate values as measured by sales. This situation has allowed farmers to borrow more money on their land to remain in business, with farm and ranch indebtedness now standing at record levels.5 This burden will in all likelihood continue to increase as total farm and ranch debt increases and as new mortgages are made and old ones refinanced. Needless to say, lenders may at some point refuse to continue to finance ranchers and farmers especially If there should be a sig- nificant and prolonged downswing in prices of livestock or land. Yet, all the family of a farmer or rancher without outside help can do to meet estate taxes Guidelines, Volume I, August, 1975, published by American National Cattlemen's Association and Cattle Marketing Information Services, Inc. 54'Farm Real Estate Market Developments, CD- 80 (1975), published by Economic Research Service of U.S. Department of Agriculture. 68-872 0 - 76 - 39 PAGENO="0610" 596 is to borrow more money or get out of business. Without some relief, economic as well as tax-wise, the future of the industry as well as the effect on the con- suming public, which depends on the industry for food and fiber, is extremely discouraging. These severe federal estate tax problems faced by the estates of farmers and ranchers have been recogmzed by President Ford and over 100 members of the Congress, who have supported various legislative proposals to remedy these problems All weather vanes point unalterably to the urgent need for immediate remethal legislation to correct these severe problems Failure of Revenue Agents to Recognize Contribution of surviving spouse to Value of Farm or Ranch Farms and ranches are frequently held In joint names by the farmer and his wife. Both husband and wife operate the farm or ranch as a team, with the wife working just as hard as her husband In such situations the husband is usually the first to die and where this occurs in common law states Revenue Agents usually contend that for federal estate tax purposes, the full value of the farm or ranch is includible in the husband s estate since the wife made no contribution to the value of the farm or ranch. To contest such contention through the administrative channels of the IRS or through court preceedings Is very expensive and time-consuming Estates of farmers and ranchers should not have to go to the time and cost of proving the obvious value of the wife s con tributlon to the farm or ranch In such circumstances E~olution to Problems NLTC ANCA NLFA and NWGA have been very concerned with the problem of higher and higher federal estate taxes caused by existing valuation policies and practices and by the illiquidity problem and have undertaken an extensive study of the subject Representatives of NLTC ANCA NLFA and NWGA have discussed this problem and some alternative solutions with members of Congress as well as with administrative and technical staff personnel As a result of these conferences and studies NLTC ANCA, NLFA and NWGA have supported bills such as H R 14249 which was first introduced In the 9Gth Congress by Congressmen Graham Purcell Jr Al Uliman James Bat tin and William Harrison and which would provide a more equitable method of valuing farms ranches and other small businesses for federal estate tax pur poses Similar bills have been introduced In both the House and Senate in each subsequent session of Congress In fact a number of the members of this Com mittee have introduced and supported bills to remedy these problems. More recently, NLTC, ANCA, NLFA and NWGA have supported legislation of the type introduced by Congressman Omar Burleson (H R 11770) by Senators McGovern (5 2875) and Curtis (5 1173) and by a number of other Congressmen and Senators on this very important subject Each of these bills has recognized the problems concerning valuation of farm and ranch land and has provided that the executor or administrator of a farmer s and rancher s estate would be permitted to value such land based upon its productive or earning capacity for agricultural purposes NLTC ANCA NLFA and NWGA support and endorse the specific valuation formula contained in Senator McGovern s bill (5 2875) which would apply not only to real property devoted to the business of farming and ranching but also to land used for the commercial production of trees `as well as for recreational purposes and scenic open space. Under the McGovern bill, real property values would be determined by dividing the average gross cash rental (less state and local real estate taxes) for comparable land for the three years immediately preceding the death of the decedent by the average interest rate of all new Federal Land Bank loans for this same three year period To qualify for such valuation, substantially all of the real property used for agricultural purposes would have to have been devoted to farming or ranching for sixty months pre ceding the farmer's death. Furthermore, the bill provides that if the real property is disposed of, other than by involuntary transfers, within five years after the decedent's death, then a recapture would be imposed which would be the difference between the federal estate tax based upon "fair market value" PAGENO="0611" 597 and the value determined by reference to rental earning capacity ifnder the bill. Senator McGovern, in introducing S. 2875, stated that this bill would result in approximately a 21% reduction in values of central corn belt land over "fair market value" figures. Precedent for Proposed Legislation There is a growing body of law which provides a precedent for enactment of such proposed legislation, such as the Burleson, McGovern and similar bills, concerning federal estate tax valuation based upon productivity or earning capacity and for a solution to this problem. To date, over 40% of the states have enacted laws regarding ad valorem taxation which provide in one form or another for the assessment of agricultural land based upon its productivity or earning capacity, rather than on market value. These laws appear to have had the desired effect of granting needed relief and providing more equitable tax treatment for farmers and ranchers. Furthermore, such laws are designed to help keep agricultural land producing food and fiber and to provide restful green belts and open space areas so vitally needed in our modern society. Recognition ~Should Be Given To Value of Wife's Contribution to Farm or Ranch Property NLTC, ANCA, NLFA and NWGA support legislation which would recognize in common law states where farm and ranch property is held in joint names by a farmer and his wife that the work performed by the wife on the farm or ranch constitutes a contribution to the value of the farm or ranch for federal estate tax purposes. Federal Estate Taa, E~remption and Marital Deduction and Gift Tao Lifetime Eoeniption and Annual Eoclusion should Be Increased There have been a flood of bills introduced in both the House and Senate, including H.R. 11770 (Burleson bill) and S. 2875 (McGovern bill), which pro- pose to Increase the federal estate tax exemption from $60,000 to $200,000 and increase the federal estate tax marital deduction to provide a minimum deduc- tion of $100,000 on property passing to a surviving spouse. These provisions apply to all estates and not just to estates of farmers and ranchers. NLTC, ANCA, NLFA and NWGA support the provisions of these bills regard- ing increasing the federal estate tax exemption from $60,000 to $200,000 and increasing the federal estate tax marital deduction to provide a minimum de- duction of $100,000. The $60,000 federal estate tax exemption has remained unchanged since 1942 while land values have increased over 200% in some instances and stocks and other property have increased tremendously in value. This has resulted in the inequitable situation where 1976 figures are applied to 1942 dollars. Based' upon the surge in the consumer price Index since 1942, one commentator has stated that the federal estate tar exemption should be in- creased to $318,000 and that based upon land Inflation during this same period, the exemption would have to be increased to $600,000.' With respect to the increase in the marital deduction, the Treasury Department has even proposed that there be an unlimited marital deduction for property passing to a surviving spouse since it is not appropriate to Impose a federal estate tax on transfers between husband wife.' NLTC, ANCA, NLFA and NWGA also support an Increase in the federal gift tax annual exclusion and lifetime exemption for the same reasons so as to reflect the effect of inflation on such amounts since they were established. Remedial Legislation Urgently Needed There Is a present and most urgent need to change present federal estate tax laws which have resulted In the liquidation of! a number of substantlal size farm `Statement of Louis Woehler to Joint Hearing of the Select Committee on Small Business and the Joint Economic Committee of the U.S. Senate on August 26, 1975 on Impact of Federal Estate and Gift f]~axes on Small Businessmen and Farmers. `Tax Reform Studies and Proposals, U.S. Treasury Department, 91st Cong. 1st Ses- sion (1969) at 29,119. PAGENO="0612" 598 and ranch operations and the conversion of needed and productive farm and ranch land to nonfarm uses. NLTC, ANCA, NLFA and NWGA feel that the previously discussed legislative proposals and bills which would permit valua- tion of farm and ranch land or productive or earning capacity represent a fair and equitable solution to these problems, even though it is recognized that in some situations the family of a deceased farmer or rancher may still experience difficulty in paying such taxes. See discussion in Exhibit A. NLTC, ANCA, NLFA and NWGA support, for all estates, an increase in the federal estate tax exemption and marital deduction, although such increases will not, standing alone, solve the present problem faced by farm and ranch estates. Such problem can only be effectively remedied If the estates of farmers and ranchers are permitted to value farm or ranch land based upon its produc- tivity or earning capacity rather than "fair market value". NLTC, ANCA, NLFA ahd NWGA also support the proposal to increase the time within which the estates of farmers and ranchers must pay federal estate taxes, such as that advanced by President Ford; however, it is felt that such proposal, by itself, will not solve the problem facing estates of farmers and ranchers, as previously explained. See also discussion In Exhibit A. Moat urgently needed, Is legislation which would permit farm and ranch land to be valued for federal estate tax purposes based upon earning or productive capacity. According to the Economics Division of the Congressional Research Service, bills which provide a method for valuing farms and similar lands on the basis of current use rather than "fair market value," such as the Burleson bill and similar bills, would result in only a $20,000,000 revenue loss. On this point, NLTC, ANCA, NLFA and NWOA firmly believe that the continued opera- tion of such economically efficient farms and ranches has a vital and far reaching economic effect upon the business community and the consuming public alike which more than offsets this small revenue loss. With the forecast of a possible crisis in our nation's food supply and the ever rising costs of doing business, it would seem prudent policy to structure our estate tax laws to help farmers and ranchers stay in business and remain productive. NLTC, ANCA, NLFA and NWGA urge this Committee's review of these seri- ous problems and the beneficial effect this proposed legislation, if enacted, would have on all farms and ranches. II. CAPITAL GAINS TAX AT DEATH SHOULD NOT BE IMPOSED NLTC, ANCA, NLFA and NWGA oppose the imposition of a capital gains tax on appreciation in value of property at the time of death or on property trans- ferred by gift. In 1963, and again in 1969 and 1973, NLTC presented its position on this subject to this Committee. The f nil presentation of NLTC's views ap- pears beginning at page 1540 of Part III, President's 1963 Tax Message, Hear- ings Before the Committee on Ways and Means, House of Representatives. NLTC, ANCA, NLFA and NWGA have taken the position that due to a com- bination of factors, the proposal to impose a capital gains tax on death or gift is especially burdensome to farmers and ranchers. First, lack of liquidity, as previously explained, is a common plague of the farmer or rancher; thus, there are often insufficient funds to pay the estate and inheritance taxes, much less a capital gains tax at death. In essence, the taxing of capital gains at death is treating death as a sale of the property, yet no proceeds are generated from which to pay the tax. The adverse effect imposition of a capital gains tax at death would have on estates of farmers and ranchers is illustrated by Dr. Hopkin's statement which appears in Exhibit A. The typical farm or ranch is an integrated economic unit and parcels cannot be sold to pay the estate and proposed capital gains taxes without lowering the value of both the part that is sold and the part that remains. Furthermore, farm and ranch land frequently cannot be sold within a few months of death since there are generally relatively few buyers, and, in order to make a sale at all, it is often required that the most desirable parts of the farm or ranch be sold, leaving the less desirable parts to be held by the heirs, making it most difficult for them to conduct an economic operation. Land is not like a portfolio of stocks which can be sold in part without loss in value. Even proponents of the capital gains tax at death recognize that estates con- sisting of farms or ranches have a substantial problem in paying taxes imposed PAGENO="0613" 599 at death because of lack of liquidity and that imposition of a capital gains tax at death would aggravate this iiquidit3~ problem.8 However, these proponents gloss over this problem with the veneer that the major share of such estates consists largely of diversified stocks and securities, which is a misstatement of the facts for relatively few farmers and ranchers' estates consist even in small, much less large, part of diversified stocks and securities. According to The Balance Sheet of the Farming Sector, 1975, publIshed by the Economic Research Service of the U.S. Department of Agriculture, preliminary figures for 1975 show assets are held by farmers in the following percentages: real estate 71.4%, livestock and poultry 4.7%, machinery and motor vehicles 10.7%, crops 4.5%, household equipment `and furnishings 3.0%, deposits and currency 2.9%, U.S. savings bonds .8% and investments in cooperatives 2.0%. Because of their ap- parent scarcity, this study states `that data is not available for estimating farmer's investments in corporate owned stocks. Therefore, it is quite clear that diversified stocks and securities do not compose a significant, much less a major share of farmers' estates. Moreover, the typical farm or ranch yields a very low return on the invest- ment, particularly at the current inflated prices for farm and ranch land. There are no excess earnings to put aside to provide for future death taxes, particu- larly when `the tax burden is compounded by the addition of a capital gains tax at death. The policy of the proposal, i.e. freeing capital that is "locked in" by the threat of capital gains tax during lifetime, is not applicable to the farming and live- stock industry. A ranch is not an investment to be turned over by the investor routinely as in the case of an investment in the stock market. A ranch or a farm is acquired to be retained and developed and to be operated and main- tained as a productive, economic unit. Finally, extension of `time for payment of the taxes is not a real solution, either, since the yield on farm and ranch properties, particularly at current price levels of land, is very low and there does not seem to be enough profit in the ranching business to pay off even the present federal estate taxes, much less an added-on capital gains tax at death. Consequently, NLTC, ANCA, NLFA `and NWGA urge this Committee to reject this proposal as it did in 1963 for the very sound reasons advanced at that time. The Carryover Basis Alternative yhould Also Be Rejected An alternativ'e proposal advanced is to provide for a carryover basis to the heirs of the decedent. One justification advanced for this `alternative proposal is that the `tax on appreciation in value will be payable when the property is actually sold, thus overcoming the very serious constitutional objections of im- posing an income tax when no income h'as been realized as is the case in the capita'l gains tax at death proposal. Analysis of such proposal, however, reveals it is undesirable in that it pre- sents a number of serious problems. First of all, `the administrative problems involved in determining a decedent's basis are difficult enough w'hen the tax- payer is living and become increasingly unmanageable the longer the property is held `after the decedent's death. Secondly, it has long been felt by those charged with the administration of the tax laws that such a proposal is un- workable since it would be very difficult in m'any cases, if n'ot impossible, to determine the cost basis of property acquired by a decedent many years previ- ously. Further, the modification of this proposal to provide that the only appre- ciation to be taxed is that `occurring subsequent to the enactment of the amendment would create an administrative nightmare similar to th'at which clogged the adminis'trative channels and the courts for many years in the determination of March 1, 1913, value of property for purposes of determining gain on the sale of property owned by the taxpayer prior to the enactment of the first income tax law. The enactment of `such a proposal might be a boon to the appraisers, accountants, and tax lawyers, but the increased administrative costs could well outweigh the increased `tax revenue realized. Additionally, since the decedent's property has been subjected to the levy and payment of an estate tax on the value of the property at the decedent's death, it 8 Kurtz and Surrey, Reform of Death and Death Tawe8: The 1969 Treatury Pro- posal8, The Critlcitm8, and a Rebuttal, 70 ColumbIa Law Review 1395 (1970) at 1389, 1397-98. PAGENO="0614" 600 seems only fair and equitable that this same value should be the tax basis of such property in the hands of the heirs Proponents of the carryover basis alternative point out that it is merely an adaptation of the existing law with respect to taxation of gifts of property given during lifetime where the basis of the donor is carried over and becomes the basis of the gift property in the hands of the donee What this overlooks is the fact that a gift during hfetime is a voluntary act and the donor is alive and well and can assist the donee in determining the basis of the property Such is not the case at death and the requirements of equitable administration of the tax laws require a clean slate so that similarly situated heirs will be treated similarly for tax purposes. If the rule were otherwise, and a carryover basis were to be enforced in the case of death, a premium would be given to the heir who could produce the tax basis records of the decedent and the heir who could not would be required to employ lawyers and accountants to haggle with the Internal Revenue Service over the computation of the amount of gain involved when the heir elected to dispose of the property at a later date In summary this Committee is also urged to reject the carryover basis alter native for the previously stated reasons III SUMMARY It is respectfully requested that the foregoing proposals and views be seriously considered. NLTC, ANCA, NLFA and NWGA would be pleased, as they have in the past, to work with the staff of this Committee in implement- ing the foregoing suggested proposals. Exhibit A AGRICULTURAL ~ IRM GROWTH AND LIQUIDITY DIMENSIONS OF Iwo PROPOSLD CHANGES IN FEDERAL ESTATE TAXES1 (By John A. Hopkin 2) An efficiently organized agricultural sector is in everyone's best interest. It results in lower food prices and released resources for other sectors of the economy. Although federal estate taxes are not an important sources of fed- eral tax receipts (less than 2 percent in 1969), the manner in which they are assessed is having an important bearing on the continuing efficiency of agri- cultural firms. Some have argued that since inheritances are windfall gains, they bear a special ability to bear a heavy tav (5). Such a statement is true for agricul- tural firms only if the business is to be dissolved. This paper will demonstrate that agriculture is ill equipped to bear a heavy inheritance tax if the goal is to continue the agricultural firm at efficient levels of production. The discussion will proceed under three headings: the economies of size within agriculture and the primary forces giving rise to it; the need for con- tinuity of management skills and financing; and the emerging liquidity crisis in agriculture. We will then consider the implications of these characteristics and needs as they relate to two important changes in federal estate laws currently being proposed. Finally, we will illustrate the likely impact of these changes on the ability of a representative commercial ranch operation to sur- vive and maintain efficiency. ECONOMIES OF SIZE Economic growth is a pervasive element of all businesses It is particulaily vital in agriculture because of the tremendous impact of new technology on production and market efficiency. Not only do new technological developments make it possible for a farmer to greatly expand the size of his operation (num- ber of acres, numbers of livestock, etc.), they make it necessary that he do so. New technology tends to place farmers on the prongs of a two-horned dilemma. One the one hand, they must adopt the new technology to remain competitive. 1Presented to the Committee on Ways and Means, March 29, 1973, Washington, D.C. 2 Stiles Professor of Agricultural Finance, Texas A&M University. The valued as- sistance of Lindon Robison is gratefully acknowledged. PAGENO="0615" 601 On the other hand when they do adopt it they must greatly expand output in order to spread the new investment and operating costs over more units of output As a consequenc~ of continuing technology most farms are substantially below the size, which, for them, would be most efficient. An Iowa State University study showed, for example, that total costs decline from about $85 per crop acre on a l60~acre Corn Belt farm to about $50 per crop acre on a 600-acre farm. This same study also showed net returns to labor and manage- ment of about $34 per acre for 600-acre farms compared to $10 per acre for farms of 160 acres (4). Figure 1 shows the findings of an important study of economies of size in farming operation in the Black Lands of Texas (8). 30 40 60 80 100 120 140 160 180 0 0 Gross income ($1,000) Fiounn 1.-Short-run average total cost curves for one- to three-man least-cost crop-livestock farms with six-row equipment at various levels of gross income In Illinois the average size of farms in 1960 was about 240 acres whereas f arm management specialists have indicated that the most efficient size for a one man cash grain farm in Central Illinois is 600-750 acres (12) The most efficient size for a two man farm in that area is nearly twice that size In a 1968 study of Minnesota dairy farms (1) the lowest cost per unit of milk production occurred on a four man operation while in Arizona the minimum cost per unit for producing milk occurred in dairy herds of 200-350 cows (6) Studies of large cattle feedlots indicate that economies of size occur In that industry up to about 30 000 head (2) Despite the almost universally present economic benefits from increasing farm size USDA studies (10 11) indicate that the only income group within agriculture that is expanding (as a group) axe those with annual sales over $20 000 No matter what one s nostalgic feelings on the matter might be agri culture is rapidly becoming a relatively large scale commercial business re quiring tremendous technical knowledge and skilled management capacities for survival Generating sufficient income attracts the equity capital supports the neces sary borrowed capital and attracts the caliber of management required for success CONTINUITY OF MANAGEMENT AND CAPITAL The sole proprietorship form of business predominates agriculture Thiq typical business setting tends to provide a high level of performance during those prune years when the proprietor is at the peak of his labor management and capital potential Unfortunately this prime condition is obtained on only a relatively small proportion of the life cycle for a typical single owner operator The schematic illustrated by situation A in Figure 2 is representa PAGENO="0616" 602 `1 5 I I .~ 0 j~.. Index of Management Level FIGURE 2.-A comparison of management level over time under two liypo- thetical situations. PAGENO="0617" 603 tive of conditions that have prevailed in many instances. It reflects the chang- ing level of management for a hypothetical single owner-operator family farm over three generations. Each generation, as a rule will have passed through tour important stages in its life cycle-namely, establishment, expansion, con- solidation, and liquidation or transfer. These four stages comprise the tradi- tional pattern for the small scale, owner-operator farms of the past. The first generation assumed to have started out at a relatively low level of manage- ment, lacking the necessary training, experience, and capital to achieve opera- tional efficiency. As these ingredients were acquired, however, the level of management rose, finally reaching a peak before dropping off as the manager approached retirement. Eventually, however, he turned the business over to his inexperienced son or son-in-law. The second generation then began to repeat this same process. However, let's assume his progress ended abruptly with the untimly withdrawal of management due to sudden illness, an accident, or death. By the time the estate was settled and new financing arranged much of the liquidity, momen- tum, and equity capital of the business were lost. The third generation essen- tially had to start over in accumulating management skills, capital and financing. Picture what might happen if farms could avoid this reorganization every generation, and be so organized that they could maintain the level of effi- ciency reached by the sole proprietorship at its peak. This situation is de- picted by the broken line in Figure 2, labelled situation B. To avoid the loss of efficiency illustrated in situation A, farms and ranches must avoid physical reorganization every generation. Large capital invest- ments, which are essential to achieve efficiency must remain intact if the second generation manager is to continue the farm operation at efficiency levels achieved earlier. A policy of estate taxation which results in larger farm and ranch enterprises being broken up and/or liquidated every genera- tion is costly in terms of losses in efficiency. Alternative policies to preserve a high level of efficiency in agriculture appear to be: (1) modification in tax laws combined with better estate planning and management, or (2) a shift in organization to the large corporation used in other industries. Part of the pressure leading toward the increased role of large corporations in agricul- ture arises from the present impact of estate taxes or farm proprietorships. THE LIQUIDITY CRISIS Another dimension of modern commercial agriculture on which our estate taxation policy has a crucial bearing is its decreasing liquidity. This condition is an outgrowth of several developing phenomena. First, the annual capital flows for machinery purchases, net land transfers, additions to inventories, etc., have been expanding steadily since the mid-fifties. Not only are annual capital flows expanding, they are increasing relfitive to total cash flows, as indicated on row 1 of Table 1 showing that the ratio of capital flows *to net cash flows increased from 42 percent in 1950-54 to 51 percent in 1970-71. During this same period, the proportion of net cash flows allocated to financing capital flows declined from 37 percent to 32 percent. As a consequence of these two shifts, the percentage of capital flow that was financed from "internal" sources (retained earnings and depreciation) decreased from 88 percent in 1950-54 to 63 percent in 1970-71. It is projected to decline further to 61 percent by 1975- 79. TABLE 1.-ANALYSIS OF FARM FINANCIAL BEHAVIOR (UNITED STATES) Analytical ratio 1950-54 1960-64 1970-71 Projection 1975-79 Ratio of capital flow to cash flow Proportion of cash flow allocated to financing capital flow (savings rate) Percentage of capital flow financed: Internally (from cash flow) Externally (by increase ri debt) 0. 42 .37 88 12 0. 44 .30 69 31 0. 51 .32 63 37 0. 52 .31 61 39 Source: Melichar (7]. The counterpart to this shift is that only 12 percent of the annual expansion tn capital flow was financed by increased debt during the 1950-54 period. By PAGENO="0618" 604 1970-71, this figure had increased to 37 percent and is projected to increase further to 39 percent by 1975-79 The information contained in Table 2 gives a further indication of the emerg ing liquidity situation for agriculture Notice the growing volume of real estate debt relative to the value of real estate Moreover the rising ratio of nonreal estate debt outstanding to production expenses (Column 2) indicates that an increasing percentage of annual operating expenses is being paid with nonreal estate debt. The trend in Column 5 shows what is happening to total debt out- standing relative to annual realized net farm income-increasing from 96.4 percent in 1950 `to 416.8 percent in 1971. TABLE 2.-THE RELATIONSHIP OF VARIOUS TYPES OF FARM DEBT TO SELECTED ASSET VALUES AND INCOME LEVELS (In percentj Real estate debt Total farm debt to Nonreal estate Total debt to to value of Year farm real estate total productive farm assets debt to production expenses Total debt to cash farm income realized net farm income 1950 7.4 ii.i 35.5 33.7 96.4 1955 8.9 13.2 44.8 36.7 156.5 1960 9.5 13.4 45.5 43.6 201.1 1965 11.9 16.7 60.1 52.7 257.2 1966 12.4 16.2 61.1 55.1 245.4 1967 12.8 18.0 64.4 64.9 312.9 1968 13.2 18.8 68.8 66.3 333.6 1969 13.4. 18.9 76.0 64.2 309.6 1970 1971 13.6 13 7 20.3 24 4 76.8 80 8 70.7 84 0 369.7 416 8 Sources The Balance Sheet of Agriculture Farm Income Situation and Agricultural Finance Review Economic Re search Service USDA Washington D C for selected years Perhaps an even clearer indication of agriculture s deteriorating liquidity is reflected in a Sources and Uses of Funds Statement based on gross cash flows. Table 3 compares estimates of gross cash flows for Texas (9) for selected years Notice the magnitude of nonreal estate loans extended and repaid relative to cash receipts from farm marketings. In fact, Texas farmers and ranchers repaid more on nonreal estate debt in 1970 than they received from farm marketings and government payments combined. Short-term debt is be- coming an increasingly important part of the cash flow of agriculture. Farmers apparently are borrowing increasingly large amounts simply to repay previous debts. TABLE 3-SOURCES AND USES OF FUNDS STATEMENT FOR TEI(AS AGRICULTURE (In millions of dollarsj 1962 1966 1970 Sources of funds: Cash receipts from farm marketings Government payments Nonfarm income Real estate debt extended Nonreal estate debt extended Real extate sales by active farmers Beginning financial assets Total sources Uses of funds: Farm operating expenses Capital expenditures Repayment of real estate debt Repayment of nonreal estate debt Real estate purchased by active farmers Ending financial assets Proprietor withdrawals: Income tax Insurance contributions Family consumption and investments Total uses 2, 580. 3 148. 5 611. 5 250. 6 2, 499. 1 373. 8 992. 2 2, 987. 7 451. 7 744. 3 413. 3 3, 968. 4 309. 3 1, 002. 5 3, 669. 7 543. 2 1, 181. 6 401. 1 5, 095. 2 304. 7 1, 385. 3 7, 456. 0 9, 877. 2 12,580.8 1, 586. 7 230. 0 154. 4 2, 418. 6 495. 9 946. 6 128.8 15. 5 1, 479. 5 1, 850. 4 338. 7 293. 3 3, 922. 4 567. 9 887. 5 132. 7 21. 7 1, 862. 6 2, 469. 9 362. 1 402. 6 5, 035. 7 497. 1 1, 236. 5 247.0 29. 1 2, 300.8 7, 456.0 9, 877.2 12, 580.8 Source: Robison, Barry, and Hopkin (9j. PAGENO="0619" 605 ESTATE TAX POLICY IMPLICATIONS When federal and estate taxes were originally established, they posed little threat to the continuity of efficient farming units. Farms were much smaller- both physically and in terms of asset value. The $60,000 exemption excluded nearly all farms in 1938 when that value was last established. Since that time, the average investment per farm in the United States has increased over 1000 percent while the exemption has remained unchanged. Under currently exist- ing circumstances, however, these taxes pose a threat to the effective con- tinuance of efficient family farm proprietorships. There are two problems. First, the magnitude of the tax is heavy relative to the income-producing capacity of the assets in question. Second, the liquidity of the business is such that a sudden drain of cash to meet estate tax demands with no corresponding increase in output (in fact, there likely would be a decrease in profits due to a change in management) threatens the continuity of the business. When an efficient productive farm unit must be liquidated to meet estate taxes, society tends to be the loser. Currently, two changes are being proposed in federal estate tax rules and pro- cedures which could materially affect agriculture's capacity to survive in essen- tially its present form. First, the National Livestock Committee and the many groups which it represents have proposed that farm real estate values be assessed for estate tax purposes on the basis of their agricultural income rather than on market value. The effect of this change would be to lower estate taxes due at the time of transfer, which is usually at death. Second, the proposal has been made that increases in value of the estate over and above its "basis" be subject to a capital gains tax at the time of transfer. The remaining discus- sion will relate to these two proposals. THE APPROPRIATE BASIS FOR DETERMINING VALUE There are a number of factors which give rise to ranch land values which are not related to the capacity of the land to generate ranch income. Yet, ranchers must depend on income to pay taxes, including estate taxes. From an economic sense, the worth of an object is determined by the present value of the projected income it can generate. Thus, an annuity which will yield $500 per year for 10 years has a present value of $3,680 if the discount rate (the cost of capital) is 6 percent. In other words, $3,680 invested now at 6 percent interest would provide a $500 payment every year for 10 years, at which time the fund would be exhausted. A government bond, on the other hand, might yield $500 per year for the next 10 years and still have a surrender value (market value) of $10,000 at the end of the period. How much is this bond worth? If one invested $5,580 now at 6 pereent compounded annually, it would be worth $10,000 in 10 years. Adding the $5,580 to the $3,680 (the present value of $500 a year for 10 years), we get $9,260, which is the worth of the bond. Again, $9,260 invested at 6 per- cent will provide an annual payment of $500 per year for 10 years plus a final cash sum of $10,000. The entire financial and investment worth is based on the concept of present value. The logic for valuing ranch land is similar. The worth to the owner is a function of four things: 1. The projected annual net cash flow. 2. The length of the planning horizon. 3. The value of the land at the end of the planning horizon. 4. The discount rate or cost of capital. For example, what is the worth of land that can be rented for $30.00 per acre, net of taxes and upkeep? (and net rents are usually the best reflection of the economic productivity of land). Assume a *planning horizon of 25 years and a discount rate of 8 percent. The present value of this cash flow stream is $320. However, the market price of the land is now $500 per acre, and is ex- pected to continue rising at a rate of 3 percent per year in the future. If so, its market value in 25 years would be $1,047. But the present value of $1,047 available 25 years from now is only $153.00 if capital costs 8 percent. Thus, the present value or worth of the land to owner is $153+$320=$473. The fact that the market price of the land is $500 now is not relevant. The land is not expected to be sold for 25 years. And $473 invested now at 8 per- PAGENO="0620" 606 cent compounded annually will supply a cash flow stream of $30 per year for 25 years plus $1,047 at the end of the 25th year. Market value is relevant only when land is sold. Only then is cash gen- erated to support that value. At other times, the logic of present value-the "capitalized income approach"-provides the most relevant basis for determin- ing value. Later, an example will demonstrate the importance of the appro- priate method of evaluation for estate tax purposes to the ability of a sound agricultural business to survive. A CASE ILLUSTRATION The impact of this proposal on the liquidity, efficiency and ultimate sur- vival power of a ranching operation can be demonstrated using an established, representative cow-calf ranching operation. The basic model ranch used for this analysis is taken from a recent manuscript being published by A. W. Epp and Robert Perry, University of Nebraska: The fStandhifls Ranch Business, 1970 and Comparisons with 1960 and 1965. It is based on a sample of 15 ranches having 350 to 600 animal units in 1970. There are 7,345 acres of owned land and 2,580 acres of leased land. The cattle herd is comprised of 330 breeding cows, 18 bulls, 96 two-year old heifers, and 97 one-year old heifers. A calf crop of 92% is assumed. Annual sales are assumed to be: 152 steer calves weighing 450 lbs., 55 heifer calves weighing 420 lbs., 77 culled cows weighing 1,000 lbs., 7 culled 2-3 year old females weighing 750 lbs., and 6 bulls weighing 1,800 lbs. The 1970 balance sheet and income statements are based on information taken from the original study and are shown in Tables 4 and 5. The entire property is held in co-ownership by a man and his wife as joini tenants. They have three children, one of whom is interested in eventually taking over this ranching operation, if appropriate financial arrangements can be made. We will assume that the father dies at the close of 1972 with the property passing to the surviving spouse. The other spouse is assumed to die at the close of 1973. Thus, all of the estate taxes paid in connection with the death of the father applies toward the tax assessments associated with the death of the mother. TABLE 4.-BALANCE SHEET, DEC. 31, 1970, FOR A TYPICAL RANCH (330 COWS) Current assets $4, 760 Current liabilities $11, 000 Cash 1, 400 Annual portion real estate loan $10, 000 Cash surrender life insurance 2,100 Annual portion real estate loan 1,000 Savings and other financial assets 1,260 Noncurrent assets 159, 413 Fixed liabilities 206, 000 Hay and feed 13,262 Real estate loan 200, 000 Livestock 121,751 Machinery loan 6, 000 Equipment 24,400 Land and improvements 457, 577 Total liabilities 217, 000 Net worth 404, 750 Total assets 621,750 Totalliabilities and networth 621, 750 TABLE 5.-INCOME STATEMENT, 1970, FOR A TYPICAL RANCH (330 COWS) Income: Livestock sales: Sale of calves $29, 733 152 steer calves, wt. 450 lb ® 330 $22, 572 55 heifer calves, wt. 420 lb, © 310 7, 161 Sale of breeding animals (capital assets) 16, 696 77 cows wt. 1,000 lb ® 210 16, 170 7 2.year old heifers wt. 750 lb © 260 1,365 6 bulls 1 880 lb ® 240 2,592 Less purchases of breeding bulls (3,431) Miscellaneous income (hunting permits, etc.) 1, ~ Total income $48, 224 Expenses ~ 535 Cash operating expenses 24, 761 Depreciation 4,514 Interest on real estate loan ($210,000 9~ .07) 14, 700 Interest on machinery loan 560 Ranch profit $3~ 689 PAGENO="0621" 607 Between 1970 and 1972 cattle prices increased by about 45 percent, permitting most ranches to operate at a reasonable profit in 1972 for the first time in nearly two decades. The income statement for 1972, as listed in Column 1 of Table 6, is based on the following prices: Percent Steer calves 48 Heifer calves 44 Cull cows 26 Heifers 37 Bulls Profits were sufficient to meet all of the demands for servicing debt and leave $7,556 for family living. The financial statement at the close of 1972 is based on the 1970 model, with the exception that livestock prices were increased by about 44 percent and land prices have been increased at an annual rate of 3 percent. Case 1: Estate Taees Based on Assessment at Market Value Let's consider first, the impact of estate taxes on this reasonably successful ranching business when the estate is valued at market. On the death of the father, on January 1, 1973, the federal and state estate taxes due would be computed as follows. Gross estate at death $510, 214 Less specific exemptions 60,000 Allowable deductions1 10, 000 Marital transfer2 250, 107 Total deductions 320, 107 Taxable estate 190, 107 Federal estate tax 47, 732 State estate tax 11, 933 Total estate tax 59, 665 1 Funeral expenses plus legal fees. 2 The gross estate less allowable deductions +2. The amount of state death or estate taxes varies by states. It is estimated here at 25 percent of the federal estate tax. PAGENO="0622" TABLE 6. INCOME, CASH FLOW, AND FINANCIAL STATEMENTS FOR A TYPICAL RANCH (330 COWS) FOR SELECTED YEARS (ESTATE TAXES BASED ON MARKET VALUE) (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 I Income statement Total Income expenses 65501 65 501 65 501 65 501 65 ~01 65 501 65 501 65 501 65 501 6~ 501 65 501 65 501 Cash operating expenses 26 051 26 051 26 051 26 051 26 051 26 051 26 051 26 051 26 051 26 051 26 051 26 051 Depreciation 5 664 5 664 5 664 5 664 5 664 5 664 5 664 5 664 5 664 5 664 5 664 5 664 Interest on real estate 14, 000 13, 300 12, 600 11, 900 16, 249 15, 708 15, 166 14, 624 14, 083 13, 541 12, 999 12, 458 Interest on machinery note 480 400 320 240 Interest on bank note 2, 603 4, 100 1, 212 2, 435 3,669 4, 915 6, 174 7, 447 8, 735 Interest on estate taxes 2, 148 4, 738 4, 212 3, 685 3, 159 2, 632 2, 106 1, 579 1, 053 526 Total expenses 46, 195 47, 563 51, 976 52, 167 51, 649 51, 794 51, 948 52, 114 52, 292 52, 483 52, 687 52, 908 Farm profits 19, 306 17,938 13,525 13, 334 13, 852 13~ 707 13~ 553 13~ 387 13,209 13, 018 12, 814 12, 593 Less Federal income tax 750 779 521 503 548 539 521 503 494 476 458 431 After-tax profits 18,556 17,159 13,004 12,831 13,304 13,168 13,032 12,884 12,715 12,542 12,356 12,162 II Cash flow statement uses Payment on real estate note 10, 000 10, 000 10, 000 10, 000 7, 738 7, 738 7, 738 7, 738 7, 738 7, 738 7, 738 7, 738 Payment on machinery note 1, ooo 1, 000 1, 000 1, 000 Payment on bank note 32, 533 51, 247 15, 152 30, 440 45, 864 61, 436 77, 177 93,091 109, 191 Payment on estate tax 5, 967 13, 162 13, 6162 13, 162 13, 162 13, 162 13, 162 13, 162 13, 162 13, 162 13, 162 ~ Family living expenses 7 556 7 556 7 556 7 556 7 556 7 556 7 556 7 556 7 556 7 556 7 556 7 556 ~ Total uses 18 556 24 523 64 251 82 965 28 456 43 608 58 896 74 320 89 892 105 633 121 547 124 485 Sources: After tax profits 18 556 17 159 13 004 12 831 13 304 13 168 13 032 12 884 12 715 12 542 12 356 12 162 New borrowings 1 371 51 247 70 134 15 152 30 440 45 864 61 436 77 177 93 091 109 191 112 323 Current assets 5 993 124 485 Total sources 18 556 24 523 64 251 82 965 28 456 43 608 58 896 74 320 89 892 105 633 121 547 Ill Financial statemen assets Total current assets 5 360 700 700 700 700 700 700 700 700 700 700 Total noncurrent assets~ 214, 365 214, 365 214, 365 214, 365 214, 365 214, 365 214, 365 214, 365 214, 365 214, 365 214, 365 Land and improvements 485 489 500 054 515 056 530 508 546 423 562 816 579 755 597 240 615 272 633 730 652 742 Total assets 705214 715 119 730 121 745 573 761 488 777 881 794 820 812 305 830 337 848 795 867 807 Liabilities: Machinery note 5 000 4 000 3 000 Bank note 1 371 51 247 15 152 30 440 45 864 61 436 77 177 93 091 109 191 Estate tax 5 967 13 162 13 162 13 162 13 162 13 162 13 162 13 162 13 162 Real estate payment 190 000 180 000 170 000 232 134 224 396 216 659 208 921 201 183 193 445 185 707 177 110 Total liabilities 195, 000 233, 102 329, 543 324, 268 318, 520 312,909 307,433 302, 105 296, 946 291, 960 287, 161 Net worth 510, 214 482, 017 400, 578 421, 305 442, 968 464, 972 487, 387 510, 200 533, 391 556, 835 580, 696 Total 705, 214 705, 119 730, 121 745, 573 761, 488 777, 881 794, 820 812, 305 830, 337 848, 795 867, 807 PAGENO="0623" 609 Federal estate taxes can be prorated over a 10-year period, at 4 percent' in- terest, if needed. Let's assume that this possibility exists for the state taxes, as well. Thus, the immediate cash flow demands incident to death and transfer would be: Funeral and legal expenses $10, 000 Down payment on federal and state taxes (10 percent of $59,665)__ 5, 967 Total 15,967 These obligations could be met with the proceeds of a $20,000 life insurance policy, leaving a cash balance of $4,033. If the wife, with the help of the family, continues to operate the ranch, as would be expected under the circumstances, there likely would be a drop-off in management efficiency of at least 10 percent, almost eliminating profits for a year or two. However, let's assume that the favorable conditions (in terms of both production and prices) which prevailed during 1972 continues each year throughout the following decade. Under these favorable assumptions, the pro- jected income statement for 1973 would be as listed in Column 2, Table 6. In addition to the cash operating expenses, listed in Column 2, new machinery would have to be purchased. Over the past `two decades new farm machinery expenditures have equalled about 1.08 percent of machinery depreciation on the typical commercial farm operation-reflecting improved technology and rising machinery prices. To be conservative, let's assume that new machinery expend- itures equals depreciation allowance each year. Cash flow must also be generated to service debt obligations falling due during 1973 and to meet family living expenses. These are listed in Column 2 as Uses, under the Cash Flow Statement (section II, A), totalling $24,523. To meet these demands, all farm profits and available savings will be consumed. In addition, $1,371 will have to be borrowed from the bank. Net worth (section III, C, Table 6) would decline by over $28,500 during 1973, despite a 3 percent increase in land values. If the surviving spouse (the wife) dies about January 1, 1974, as we have assumed for this illustration, the new estate taxes would be computed as follows. Gross estate 481, 573 Less: Specific exemptions 60,000 Allowable deductions `18, 000 Taxable estate 403,573 Federal estate tax 114, 843 State estate tax 2 28, 711 Total estate tax due 143, 554 Less payments on father's estate 11, 934 Net estate taxes due 131, 620 `Funeral expenses plus legal and probate fees. 2 Assessed equal to 25% of federal estate tax. The immediate cash demands for estate settlement, again assuming a 10-year repayment privilege for both state and federal estate taxes would be: Funeral, legal, and probate costs $18, 000 10 percent payment on estate taxes 13, 162 Total 31,162 By borrowing $31,162 more from the bank these demands can be met. Alterna- tively, sufficient breeding stock could be sold to generate this cash. Because sell- ing breeding stock would reduce sales and efficiency, the choice would be to borrow the money, if possible. The remaining columns of Table 6 demonstrate all too clearly the impact of the estate taxes on this business. Even assuming that (1) the high price levels of 1972 continue on through the decade, (2) machinery and operating costs remain constant at the 1972 level, and (3) land values increase at 3 percent per year, this business still could not survive. To meet the increased cash flow required to service debt would require increased borrowings. 1 7% interest as of February 1, 1976. PAGENO="0624" 610 At same point the lender will require the rancher to refinance his real estate thereby picking up enough funds to retire bank debt carryovers This is done in 1975 shown in Column (4) Even when the real estate debt is spread out over 30 years, the cash flows still cannot be met resulting again in increased bank borrowings each year By 1977 lenders undoubtedly would be so discouraged by trends in profits and low carryovers that they would force liquidation Although net worth continues to increase due to rising land values this rather typical and productive ranching enterprise cannot survive the incidence of intergeneration transfer resulting from the death of the parents Similar instances are occurring throughout agri culture with sufficient frequency to be a matter of major concern Case 2 Estate Taa, Assessment Based on Capitalized Income If instead of valuing the estate at market value the real estate were to be evaluated on the basis of capitalized income the estate would be valued as follows The financial assets at face value $2 660 Feed and livestock at market value 188 565 Equipment at cost less depreciation 25 800 Real estate valued at present value of projected cash flow stream~. 335 373 Total value of assets 552 398 Less total liabilities 195 000 Value of the estate 357 398 The real estate values were determined as follows Projected annual after tax ranch income $18 556 Income allocated to nonreal estate assets valued in the estate at~_ 217 025 On the basis of 5 percent 19 851 Estimated annual return to real estate 18 556-b 851 *7 705 *Aiternatjvely the rental value of the real estate can usually be estimated based on rental rates in the area. The "residual income" approach used here would be resorted to only when rental rates were not available. A planning horizon of 25 years and a discount rate (cost of capital) of 6 percent is assumed. It is also assumed that land will continue to increase at the rate of 3 percent per year Thus its market value at the end of 25 years should be $1 016 614. We now want to determine a sum which, if invested at 6 percent compounded annually would provide an annual annuity of $7 705 and have a remaining cash sum of $1 016 614 From an annuity table we can find that $12 784 invested at 6 percent will provide an annuity of $100 for 25 years Thus (12 784) (7705) = 98501 $98 501 would be needed to provide an annuity of $7 705 Moreover 233 cents invested today at 6 percent compounded annually will be worth $100 in 25 years Therefore we must invest 233 (1 016 614) =$236 872 now to provide a sum equal to the expected market price of the asset in 25 years By combining these we obtain the present value of the projected income stream attributable to the real estate $98 501+236 872=$335 373 Based on the above estate valuation the estate taxes would be Gross value of the estate $357 398 Less 243, 699 The specific exemption 60, 000 Allowable deductions 10,000 Marital deduction 173 699 Taxable estate 113 699 Federal estate tax 24 810 State death taxes (estimated at 25 percent of federal tax) 6 203 Total taxes 31 013 If the $31 013 state and federal estate taxes were prorated over a four year period the immediate cash outflow associated with the death and transfer ($10 000 funeral and legal expenses plus $31 013/4) of $17 753 could be met with the insurance proceeds of $20 000 and leave $2 247 to be added to cash The PAGENO="0625" 611 projected after-tax income for 1973 would be as listed in Part I, Column (1), Ti~bie 7=$18,280. Again, let's make the same conservative assumption that cash reserved for depreciation will meet the requirements for machinery purchases. In addition to machinery purchases, cash operating expenses and interest, cash flows of $26,309 must be met for 1973 (see Part IT-A, Column (1), Table 7). This cash flow can be met as follows: From after-tax profits $18,280 Borrow from bank 3, 822 From cash, savings, and insurance 4, 207 Total 26,309 68-872 0 - 76 - 40 PAGENO="0626" TABLE 7.-I NCOME, CASH FLOW, AND FINANCIAL STATEMENTS FOR A TYPICAL RANCH (330 COWS) FOR SELECTED YEARS (ESTATE TAXES BASED ON "CAPITALIZED" INCOME VALUE) (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 I. Income statement Total income $65, 501 $65, 501 $65, 501 $65, 501 $65, 501 $65, 501 $65, 501 $65, 501 $65, 501 $65, 501 $65, 501 Expenses: Cash operating expenses 26, 051 26,051 26,051 26,051 26,051 26, 051 26,051 26, 051 26,051 26, 051 26, 051 Depreciation 5,664 5, 664 5,664 5,664 5,664 5, 664 5, 664 5,664 5,664 5,664 5,664 Interest on real estate 13, 300 12,600 11, 900 14, 797 14, 304 13, 811 13,317 12, 824 12, 331 11, 838 11, 344 Interest on machinery note 400 320 240 Intereston bank note~ 2,198 3,082 499 977 1,431 1,860 2,262 2,634 2,975 Interest on estate taxes 930 2, 757 2, 451 2, 145 1,838 1, 532 1, 225 919 613 306 Total expenses 46345 49 590 49 388 48 657 48 356 48 035 47 688 47 318 46 921 46 493 46 034 Farm profits 19,156 15,911 16,113 16,844 17,145 17,466 17,813 18,183 18,580 19,008 19,467 Less Federal incometax 876 741 760 826 855 882 914 938 970 1 011 1 044 After-tax profits 18,280 15, 170 15,353 16,018 16, 290 16,584 16,899 17,245 17,610 17,997 18,423 c~ -====== II. Cash flow statement Uses: Payment on real estate note 10,000 10,000 10,000 7,046 7, 046 7, 046 7,046 7,046 7,046 7,046 7,046 Payment on machinery note 1 000 1 000 1 000 Payment on bank note 27 481 38 526 6 243 12 214 17 891 23 253 28 269 32 920 37 182 Payment on estate tax 7, 753 7, 659 7,659 7, 659 7, 659 7, 659 7, 659 7,659 7, 659 7,657 Familylivingexpenses 7,556 7,556 7,556 7,556 7,556 7,556 7,556 7,556 7,556 7,556 7,556 Total uses 26 309 53 696 64 741 22 261 28 504 34 475 40 152 45 514 50 530 55 179 51 784 Sources: After-tax profits 18,280 15, 170 15,353 16,018 16,290 16,584 16,899 17, 245 17,610 17,997 18,423 Net borrowings 3,822 38, 526 49,388 6,253 12,214 17, 891 23,253 28,269 32,920 37, 182 33, 361 Current assets 4,207 Total sources 26 309 53 696 64 741 22 261 28 504 34 475 40 152 45 514 50 530 5517951784 III. Financial statement Assets: Totalcurrentassets 700 700 700 700 700 700 700 700 700 700 Total noncurrent assets 214,365 214,365 214,365 214,365 214,365 214,365 214,365 214,365 214,365 214,365 Land and improvements 500, 054 515, 056 530, 508 546,423 562,816 579,755 597,240 615,272 633,730 652,742 Total assets 715, 119 730, 121 745, 573 761, 488 777, 881 794, 820 812, 305 830, 337 848,795 867, 807 PAGENO="0627" liabilities: Machinery note - 4,000 3,000 - Bank note 3,822 38,526 6,243 12,214 17,891 23,253 28,269 32,920 37,182 Estate tax note 15,506 61,274 53,613 45,954 38,295 30,636 22,977 15,318 7,657 Real estate payment 180,000 170,000 211,388 204,341 197,295 190,249 183,203 176, 156 169, 110 162, 064 Total liabilities 203,328 272,800 265,001 256,538 247, 804 238,776 229,433 219,743 209,687 199,246 Net worth 511,791 457,321 480,572 504,950 530,077 556,044 582,872 610,594 639,108 668,561 Total 715,119 730,121 745,573 761,488 777,881 794,820 812,305 830,337 848,795 867,807 PAGENO="0628" 614 Let's also assume that the surviving spouse, the wife, dies on January 1, 1974. Assuming the land is again appraised based on the present value of the projected cash flows using the same assumptions as a year earlier, its appraised value would be essentially the same. Thus, the wife's estate would be valued on December 31, 1973, at: Financial assets $700 Noncurrent assets 214,305 Real estate 335, 373 Total assets 550,438 Total liabilities 190, 506 Total value of the estate 350, 932 The estate taxes due would be: Gross value of the estate $350, 932 Less: Specific exemption 60, 000 Allowable deductions 10,000 Taxable estate 274,932 Federal estate tax 73,678 State death taxes (estimated at 25 percent of Federal) 18, 420 Total State and Federal taxes 92,008 Less payments made on father's estate 15,506 New State and Federal estate taxes due 76,592 If we continue our assumption that both state and federal estate taxes can be prorated over 10 years, the immediate cash demands for estate settlement would be: Funeral, legal and probate costs $16,000 10 percent payment on estate taxes 7,659 Total 23, 659 To meet these payments, the heirs will have to borrow an additional $23,659 bringing the total `bank debt up to $27,481. Column (2), Table 7 shows that income would decline the next year (1974) as would net worth, while bank borrowings increase. In 1975 the real estate will be refinanced with a 30-year, 7 percent loan, thus permitting the bank loan carryover to be paid. Even so, new bank borrowings will be required to meet cash flow for 1976. Moreover, the bank loan would increase each year through 1982, reaching a peak of $37,182, then `start to decline. Although the uptrend of this loan carryover is not encouraging, the size of the loan is modest relative to the value of the cattle. More importantly, after-tax profits show a gradual upward trend. Consequently, if the heirs have an understanding banker and our favorable assumptions prevail, the business can survive the impact of estate taxes where the assessed values are based on capitalized income. And the survival of this type of firm for continued efficient food production should be an important policy objective. THE IMPACT OF A CAPITAL GAIN5 TAX ASSESSED AT TRANSFER The second proposed change in estate tax laws which would materially affect agriculture would make increases in the value of the assets over and above its "basis" subject to capital gains tax at the time of transfer. This would be in addition to both state and federal estate taxes which currently are assessed at that time. This change would put a heavy additional burden on the liquidity of the business at the precise time when it is least able to bear it. Not only is no income generated at transfer, estate taxes and other costs incident to transfer, plus the generally lower level of profits occurring at such times, al- ready have placed the firm in a serious liquidity bind. Both the traditional concept and use of capital gain relates to income realized from the sale of assets which~ have been held for specified periods and which PAGENO="0629" 615 result from increases in the price of the asset during the holding period. Clearly, `the intergeneration transfer of farm and ranch properties does not generate capital gains, since no sale has occurred. In most instances, both the time and incidence of transfer are outside the control of the transferor. To change the concept and policy so as to require taxes on capital gains before assets have been sold merely because the hypothetical "market price" of the asset has risen could have far-reaching implications. Moreover, there is no need for this change since the capital gains tax will ultimately be collected when the asset is' finally sold. Case 3: Capital Gains Taw Assessed at Transfer This example will illustrate the impact of the impositionof a capital gains tax at transfer. We will use the same 330-cow ranch illustrated earlier and assume that a capital gains tax was assessed at the death of the father. Although there were no capital gains in the traditional meaning and use of the term since no assets were sold, we will redefine capital gains for this purpose as the difference between the "basis" and the appraised value of the property at death. If we begin with the 1970 inventory value of physical assets and assume that this figure represents his "basis" after 25 years of growing at an annual rate of 3 percent per year, the "basis" then, would be $404,750 (1.03Y~ or $192,256. The capital gains at death would be $348,258, which is the difference between his "basis" and the net worth of hi's assets valued at "market." The capital gains tax owed on this amount comes to $121,890. We have already seen that this ranch could not withstand the liquidity strain of estate taxes based on market value of assets, even when they were prorated over 10 years. Even when estate taxes were based on the "capitalized income" value of the real estate, the firm could barely survive the first 10 years. To impose an additional capital gains tax of any magnitude on the business at the crucial time of estate transfer, when the business is already undergoing a liquidity crisis, imposes an additional cash burden that few, if any, farms or ranches could survive. By the very nature of the industry, when the capital gains tax is assessed it will be so large that the farm business will have to be liquidated to meet it. From both the standpoint of economic efficiency in food production and logical consistency with the very concept of capital gains, it should be assessed only when the property is sold. REFERENCES (1) Buxton, B. M. and H. H. Jensen, Economies of size in Minnesota Dairy Farms, University of Minnesota, Agricultural Experiment Station Bulletin 488, 1968. (2) Hopkin, John A., "Economies of Size in the Cattle Feeding Industry of California," Journal of Farm Economics, Vol. 40, No. 2, May 1958. (3) Hopkin, John A., Peter J. Barry, and C. B. Baker, Financial Management in Agriculture, The Interstate Printers and Publishers, Inc., Danville, Illinois, 1973. (4) Inhen, Loren and E. 0. Heady, "Cost Functions in Relation to Farm Size and Machinery Technology," Research Bulletin 527, 1964, Ames, Iowa. (5) ICurtz, Jerome and Stanley S. Surrey, "Reform of Death and Gift Taxes: The 1969 Treasury Proposals, The Criticisms and a Rebuttal," Columbia Law Review, Vol. 70, 1970, pp. 1365-1401. (6) Martin, W. E. and J. S. Hill, Cost-site Relationships for Central Arizona Dairies. The University of Arizona, Agricultural Experiment Station Tech- nical Bulletin 149. (7) Melicher, Emanuel, Financing Agriculture: Demand for and F~1upply of Farm Capital and Credit, Board of Governors, Federal Reserve System, Washington, D.C., December 1972. (8) Moore, Donald and Carl Anderson, "Economies of Size on Farms in the Blackland Area of Texas," B-1125, October 1972, Texas Agricultural Ex- perimen't Station, College Station, Texas. (9) Robison, Lindon J., Peter J. Barry, and John A. Hopkln, Cash Flows and Financing in Tewas Agriculture, Department of Agricultural Economics and Rural Sociology, Texas A&M University, College Station, January 1973. (10) Senate Document No. 44, Parity Position of Farmers, U.S. Government Printing Office, Washington, D.C., 1967. PAGENO="0630" 616 (11)U.S. Department of Agriculture, The E~vpanding and the Contracting sec- tois of Amerwan Agrwutture Ag Iko Report No 74 Washington D C May 19~5 (12) Van Arsdale R N and W A Elder Eeon~mres of ~rze of Illinois Oasis arain and Hog Farms University of Illinois Agricultural Experiment Station Bulletin 733 l9~l9 The CHAIRMAN We will hear from you now, Mr Brannon STATEMENT OP GERARD M BRANNON Mr BRANNON I have a practical political plan It is underhanded but not illegal The plan is this you set up a program for low interest loans to people who want to buy farms and small businesses I know you have heard this before but the unique part of my plan is that you only give these benefits to rich people fhese are the kind of people who can be politically grateful Does some hardworking poor boy want to own a farm ~ Kick him in the teeth He would need all the money for the farm As I see it there is only one drawback to this plan President 1~ oid has proposed it already The thrust of President Ford's proposals to defer estate tax on family farms and family businesses is basically low interest loans to rich people. Taxable estates are left only `by the richest seven percent of decedents and only in a much smaller group is the estate tax significant As you can tell from my sarcasm I regard the President's plan as bad tax policy and I similarly regard the proposals for increasing the estate tax exemption This committee should not do a knife job on `the estate tai without first giving serious thought to the role of death taxes in our tax sys- tem. In my opinion this serious reconsideration of the estate tax should lead you to making it more, not less effective During your panel discussions on tax reform in 1973 I submitted a statement about the estate tax which I asked be included in this record AN OVERVIEW O} DEATH TAXES The estate and gift taxes must be considered in the light of tlu basic dilemma of our tax system, which is to combine equity and efficiency We have a capitalist system and we need to make it work efficicnt~y What makes capitalism work is the incentive to earn money One ot the disadvantages of capitalism is the extremes of wealth and poverty that it generates., which is why we have progressive taxes and poverty relief There are limits to our ability to attack this wealth accumulation process directly This is the problem of incentives Because of this problem you are constantly moderating income tax progressivity with things like investment credits I believe that an eminently sensible way to deal jointly with the efficiency and fairness issues is to impose heavy taxes on the transfer of accumulated wealth between generations. Death taxes should be regarded in part as an alternative to taxes on income. PAGENO="0631" 617 You could achieve a given degree of progressivity in the tax sys- tem by means of lifetime income taxes or by taxing the transfer of accumulated wealth between generations. It is, I think self evident that the incentive effects of direct income taxation are more severe than the indirect effects of the knowledge that less of his accumula- tion can be passed on. Notice that I have not urged you to make the tax system more progressive. If you think that the total tax system is too progressive, you should not cut estate taxes but instead cut income taxes `and simul- taneously close estate tax loopholes. If you want more progressivity, do not cut either one, but instead close some of the escape routes under the present death tax system. However you come out on the basic progressivity issue, the im- mediate advice is the same, increase, don't reduce death taxes. DESIRABLE CHANGES IN DEATH TAXATION There are serious issues in making death taxation more uniform. The most important problem in death taxation is the failure to tax unrealized appreciation at death. The death tax is basically a double tax. It falls on the part of wages, salaries, dividends, interest, rent, royalties and unincorporated business profit which are accumulated after income tax. Wealth accumulation that occurs from unrealized appreciation never is subjected to income tax. Consider two individuals A and B; each has an annual income of $50,000 subject to income tax with the income after tax used to finance consumption. A has an investment account initially $1 million which produces another $50,000 of income subject to an annual tax of 50 percent with the balance saved. B has an investment account initially $1 million which appreciates by an average of $50,000. After 20 years B's investment account will have risen to $2 million because it never paid income tax. A's investment account rises only to $1.5 million. Before imposing estate tax there should be a capital gains tax on B's accumulation. The amount of the capital gains tax would be deducted from the estate before computing estate tax. Another important change in death taxation would be to unify the estate and gift tax. The gift tax rate should be raised to the estate tax level, the tax should be included in the base as it is for estate tax purposes and the estate transfer should be treated as the final gift, that is it should be cumulated with prior gifts. A third important change in death taxation would be to impose an extra tax on generation skipping transfers. A basic set of recommendations for implementing these changes are contained in the Treasury Tax Reform Studies and Proposals published by this committee in 1969. Another important change in the estate tax would be to expand the marital deduction. There should be a 100 percent marital deduction up to some amount of the economic estate, say $200,000-which should include the value of any survivor annuity purchased by the de- cedent. There would still be the 50-perecnt deduction beyond this. I do not think that the estate tax should fall heavily on the wealth that the decedent would have used to support the spouse if death PAGENO="0632" 618 had not intervened This is not an rntegeneration transfer of ac cumulated wealth The marital deduction should also be expanded to cover some mod est amounts for orphan children When the richer spouse dies it is obvious to use the marital deduction to leave property to the surviv ing spouse for raising the children. If a widow or widowe.r dies, I would like to avoid death tax on a basic amount that would have been provided for supporting children to majority if the parent had lived This amount might be $4,000 times each child's age subtracted from 21 If the marital deduction is expanded in this way, there should be no increase in the basic $60,000 estate tax exemption Except foi the cases that I have described, estates are normally left to grown chil dren and their receipt is essentially a windfall income When my parents die I will come into a modest estate which will be on top of a good income There is no justification for a whopping big exemp tion The exemption should only be expanded by the expansion of the marital deduction to deal with cases in which death takes away a major source of current support ILLIQUID BUSINESS PROPERTY I return to the issue that is prominent in these hearings, the trans fer of illiquid estates of an interest in farms or businesses It is alleged that tax relief is called for here because the tax may be a factor in the sale of the business interest to a large firm This problem is easily exaggerated In the first place a business owner can provide some liquidity The most convenient method is by life insurance If you look at this from a business standpoint you will realize that a business person incurs illiquidity in order to get a larger return If the owner of a business wants to incur this largei risk for larger rewards, there is no need to provide special relief Secondly, the owner of a business can under present law transfei considerable business interest at considerable tax saving by means of lifetime gifts If we get around to closing the gift tax loophole, one could talk about some gift incentive, as I have done in the paper If you are concerned about increasing business concentration, the proper way to do something is to tighten the merger rule under the Clayton Act Also you could look for ways to facilitate business entry by loans Such a loan program, however, should have general applic ability It should not be restricted to the heirs of rich decedents Finally, there is a provision in the present law for deferred pay ment of estate tax, a provision that is little used I think that the disuse is connected with the contingent liability on the executor oi the other heirs if the business fails and a large estate tax liability ie mains It would be wise to examine the possibility of dealing with this case where the remaining value of the business falls below the remaining tax liability In this circumstance the estate tax liability could be reduced but the provision would have to be carefully dra~yn to take account of other estate assets that could pay the tax and to prevent milking of the business by the heirs Thank you The CHAIRMAN I thank you PAGENO="0633" 619 Mr. BRANNON. I would like to submit the longer statement for the record. Mr. Burleson [presiding]. Without objection, your full statement will be included in the record. [The prepared statement follows:] STATEMENT OF GERARD M. BRANNON, PROFESSOR OF ECONOMICS, GEORGETOWN UNIvERsITY Members of the committee, I recognize that YOU are concerned about prac- tical politics. I have a very practical political plan; it is dirty and under- handed but it would not be illegal. The plan is this: you set up a program to make grants and extend low interest loans to people who want to buy farms and small businesses. I know you have heard this before but I haven't gotten to the hooker yet. The unique part of this plan is that you only give these benefits to rich people. These are the kind of people who can be politically grateful. Does some hardworking poor boy want to own a farm? Kick him in the teeth. He would need all the money for the farm. As I see it there is only one drawback to this plan. President Ford has pro. posed it already. The thrust of President Ford's proposal to defer estate tax on family farms and family businesses is basically a scheme to make interest free loans to rich people. Taxable estates are left only by the richest 7% of decedents and only in a smaller group is the estate tax significant. As you can tell from my sarcasm I regard the President's plan as bad tax policy and I similarly regard his proposals for increasing the estate tax ex- emption. It would be a very serious mistake for this Committee to proceed with a knife job on the estate tax without first giving serious thought to the role of death taxes in our tax system. In my opinion this serious reconsideration of the estate tax should lead you to making it more, not less effective. During your panel discussions of tax reform in 1973 I submitted a statement about the estate tax which I asked be included in this record, (I also elabo- rated these ideas in "Death Taxes in a Progressive System," National Taa, ,Journal September, 1973. AN OVERVIEW OF DEATH TAXES The estate and gift taxes must be considered in the light of the basic dilemma of our tax system, which is to combine equity and efficiency. We have a capitalist system and we need to make it work efficiently. What makes capitalism work is the incentive to earn money. One of the disadvantages of capitalism is the extremes of wealth and poverty that it generates, which is why we have progressive taxes and poverty relief. There are limits to our ability to attack this wealth accumulation process directly. This is the problem of incentives. Because of this problem you are constantly moderating income tax progressivity with things like investment credits. I believe that an eminently sensible way to deal jointly with the efficiency and fairness issues is to impose heavy taxes on the transfer of accumulated wealth between generations. Death taxes should be regarded in part as an alternative to taxes on income. You could achieve a given degree of progressivity in the tax system by making lifetime income taxes more severe or by taxing the transfer of accumu- lated wealth between generations. It is, I think self evident that the incentive effects of direct income taxation are more severe than the indirect effects of the knowledge that less of this accumulation can be passed on. (For further evidence I cite the fact that wealth owners do not come near to transferring an amount of poverty by gift that would minimize total transfer taxes. They attach greater importance to having more property themselves than leaving more for their heirs. See Carl Shoup Federal Estate and Gift Ta~ves, pp. 17-25. Notice that I have not urged you to make the tax system more progressive. (I have my own views on progressivity but they are not relevant to this point.) Some of you think that the tax system is too progressive already; some of you PAGENO="0634" 620 think it is not progressive enough. Right now I den't get into that argu- ment. I am only saying that at the margin death taxation is a better route to progressivity than income taxation It follows that if you think that the total tax system is too progressive, you should not cut estate taxes but instead cut income taxes and simultaneously close estate tax loopholes If you want more progressivity do not cut either one, but instead close some of the escape routes under the present death tax system. However you come out on the basic progressivity, the immediate advice is the same, increase, don't reduce death taxes. DESIRABLE CHANGES IN DEATH TAXATION There are serious issues in making death taxation more uniform. For the most part these would increase revenue and would take this increase from the wealthiest 7% of the population If you want to make the tax system no more progressive than it is now you should use this revenue to cut income taxes in the top brackets If you want the tax system to be more progressive you would use the revenue for more general tax reduction I don t go into the matter of how to use the revenue The most important problem in death taxation is the failure to tax un- realized appreciation at death The death tax is basically a double tax It falls on the part of wages, salaries, dividends, interest, rent, royalties and un- incorporated business profit which are accumulated after income tax. Wealth accumulation that occurs from unrealized appreciation never is subjected to income tax. Consider two individuals A and B each has an annual income of $50 000 subject to income tax with the income after tax used to finance consumption A has an investment account initially one million dollars which produces another $50,000 of income subject to an annual tax of 50% with the balance saved B has an investment account initially one million dollars which appre ciates by an average of $50,000. Alter 20 years B s Investment account will have risen to $2 million because it never paid income tax A's investment rises only to $1.5 million. Before im- posing estate tax there should be a capital gains tax on B's accumulation. The amount of the capital gains tax would be deducted from the estate before computing estate tax. Another important change in death taxation would be to unify the estate and gift tax. The gift tax rate should be raised to the estate tax level, the tax should be included in the base as it is for estate tax purposes and the estate transfer should be treated as the final gift, that is it should be cumulated with prior gifts. If you have an insatiable urge to provide incentives for early transfer, the way to do this would be to provide a lower rate of tax on a limited amount of property transferred outright to a person who had attained majority. (Only in this case is wealth control actually diluted. Incentives to make transfers in trust are pointless except to make business for trust officers.) A third important change in death taxation would be to impose an extra tax on generation skipping transfers. A basic set of recommendations for implementing these changes are con- tained in the Treasury Tax Reform Studies and Proposals published by this Committee in 1009. Another important change in the estate tax would be to expand the marital deduction. There should be a 100% marital deduction up to some amount of the economic estate, say, $$200,000 (which should include the value of any survivor annuity purchased by the decedent). There would still be the 50% deduction beyond this. I do not think that the estate tax should fall heavily on the wealth that the decedent would have used to support the spouse if death had not intervened. This is not an intergeneration trahsfer of accumulated wealth. The marital deduction should also be expanded to cover some modest amounts for orphan children. When the richer spouse dies it is obvious to use the marital deduction to leave property to the surviving spouse for raising the children. If a widow or widower dies, I would like to avoid death tax on a basic amount that would have provided for supporting children to majority if the parent had lived. This amount might be $4,000 times each child's age subtracted from 21. PAGENO="0635" 621 If the ma~rital deduction is expanded in this way, there should be Increase in the basic $60,000 estate tax exemption. Except for the cases that I have described, estates are normally left to grown children and their receipt Is essentially a windfall income. When my parents die I will come into a modest estate which will be on top of a good income. There is no justification for a whopping big exemption. The exemption should only be expanded by the expan- sion of the marital deduction to deal with cases in which death takes away a major source of current support. ILLIQUID BUSINESS PEOPEETY I return to the Issue that is prominent in these hearings, the transfer of ill!- quid estates of an Interest in farms or businesses. It is alleged that tax relief Is called for here because the tax may be a factor in the sale of the business interest to a large firm. This problem is easily exaggerated. In `the first place a business owner can provide some liquidity. The most convenient method is by life insurance. If you look at `this from a business standpoint you will realize that a business-person incurs liquidity in order to get a larger return. If the owner of a business wants to incur this larger risk for larger rewards, there is no need to provide special relief. Secondly, the owner of a business can under present law transfer considerable business interest at considerable tax saving by means of lifetime gifts. If we get around to closing the gift tax loophole, one could talk about some gift in- centive, as I have done above. If you are concerned about increasing business concentration, the proper way to do something Is to tighten the merger rule under the Clayton Act. Also you could look for ways to facilitate business entry by loans. Such a loan pro- gram, however, should have general applicability. It should not be restricted to the heirs of rich decendents. Finally, there Is a provision in the present law for deferred payment of estate tax, a provision that is little used. I think that the disuse is connected with the contingent liability on the executor or the other heirs if the business fails and a large estate tax liability remains. It would be wise to examine the possibility of dealing with this case where the remaining value of `the business falls below the remaining tax liability. In this circumstance the estate tax liability could be reduced but the provision would have to be carefully drawn, to take account of other estate assets that could pay the' tax `and to prevent the milking of the business by the heirs. CONCLUSION In conclusion, this Committee should deal with substantive estate tax re- form. This reform should close the major loopholes, unrealized appreciation at death, the lower gift tax rate and generation skipping. It should also expand the marital deduction. There should no increase in the estate tax exemption. There should be no significant change in the deferred payment provisions although some modification of the continuing liability in the light of business failure should be considered. Mr. VANIK. Mr. Chairman, I know we are ready to vote but I just want to tell Mr. Brannon I very much appreciate his statement. I appreciate his objectivity. You do suggest some help. You suggest a greater need to legislate, and I appreciate your work on this matter. Mr. BURLESON. The committee will adjourn or recess for about ten minutes for us to answer this quorum call. [A recess was taken.] Mr. BURLESON. The committee will come to order and we will now hear Mr. Cunningham. STATEMENT OP T. A. CUNNINGHAM Mr. CUNNINGHAM. Thank you, Mr. Chairman. I certainly appreciate being here. PAGENO="0636" 622 I am T. A. Cunningham, President of the Independent Cattlemen's Association of Texas. I represent the Calves Association. I have a prepared statement, and if you would accept that for the record, I would just like to talk to you a little bit. Mr. Bulu~soN. Your full statement will be introduced in the rec- ord and you may proceed in summary. Mr. CUNNINGHAM. We would like for you to think just a minute about whenever you leave the world exactly what you leave behind you. You leave your accomplishments, the marks that you make, what you have been able to do for your neighbor, your nation, your children, and what you are leaving to them. rihat is the reason this bill is so important to our people. They work a lifetime to pay for something to improve their ranches, farms, and small businesses to where they can pass them on to their children and grandchildren. The only way I can hold onto my ranch is to keep living. If I were to die tomorrow, my sons would have to sell my ranch. There is no waVy to hold it. I would like for you also to think for a minute of this: We have the greatest agriculture in the world. We produce food for the American people for 17 cents on the payroll dollar. The closest thing to us is roughly 40 cents. A lot of countries are as much as 80 percent. We have a little less than 4 percent of the people in the nation doing this. Not only that, but we can feed half of the rest of the world. With a great agriculture like that I can't understand how anyone would want to kill the goose that lays the golden egg. There is no better food, no better inspected food or cleaner food in the world than what comes from our people in agriculture. Now, a lot of people in the city look at it and say, "Why would anyone stay out there and struggle through a drought, storms, and everything else to hold onto their land?" There is only one thing, to pass it on to their children and grand- children. If you take that incentive out, which is what is happening at this time, they give up. You have to understand that the people in agricul- ture are sick, they are tired, and they are fed up. They tell them to grow grain from fence to fence and a lot of my members did. What happens? They bust the market and it breaks them. Then what happens to beef? They tell them in 2 years they won't be able to produce beef to feed this market. They said we produce too much beef and broke everybody in the livestock industry. This bill here will probably be the most important bill that I will live to see, because this bill, if it is not tampered with too much, will be the thing that will let some of those people regain some con- fidence that they can build up an estate and pass it on to their chil- dren and their grandchildren. Of course there is another part that is tearing us up and that is what you have heard testimony about. There are people who have to sell their land to pay their estate taxes. They cut it up in small pieces and sell it to people retiring, which I don't think is anything wrong, because the man lived a lifetime to buy a small place to live on, that is all right. PAGENO="0637" 623 At the same time, here comes IRS and appraises your land accord- ing to the last four sales around you. Maybe that man sold a small parcel of it at $1,000 per acre. You have to understand that we are getting less for a calf today than we got in 1946. Our costs of trac- tors and fuel and everything else has gone up 306 percent. It makes one wonder how long we can stay. This will be one thing to give us some hope, if we can get a market back where we can hang on. I would like to go back and tell my people that I felt that this committee felt very favorable about pass- ing this bill to the full committee, and make it a law. I think this would give them more hope than any one thing I could tell them to- day. They don't have any confidence in USDA, and if they can hang on to the confidence in the House and Senate perhaps that will keep them in agriculture. You have to realize that we don't have one man between 18 and 25 going into agriculture to replace every 117 that is over 60. In 5 years I want to know who is going to produce the food. We cannot get our children to stay on the farm or ranch. When they know when we die if they don't have to sell the place they have to borrow money that will take them 20 or 30 years to pay for it, and when they die then their children will have to borrow it for another 20 or 30 years, and there isn't much incentive in that. You can't get it done that way. I think that, or I know that, the Representatives from Texas understand the position in our area. I don't know if the Representa- tives from the cities do understand how the people in agriculture feel today. It is a very good bill. It will add a lot of confidence and I cer- tainly hope you will get it through. Mr. BURLESON. Thank you. Mr. CUNNINGHAM. Thank you. [The prepared statement follows:] STATEMENT OF T. A. CUNNINGHAM, PRESIDENT, INDEPENDENT CATTLEMEN'S ASSOCIATION OF TEXAS Mr. Chairman and members of the committee, my name is T. A. Cunning- ham, and I am President of the rndependent Cattlemen's Association of Texas. I submit the following position statement of the Association on H.R. 1793 by Congressman Omar Burleson of Texas and other of your distinguished col- leagues. The Independent Cattlemen's Association of Texas, while still a relatively new organization, has a membership of in excess of 100,000 members. The very depressed livestock market, the unrestricte~I importation of meat and meat products into the United States from foreign countries, and the apparent loss of recognition of the value of the agricultural and livestock industry to our United States were a few of the principle reasons which caused the rapid growth and interest in the Independent Cattlemen's Association of Texas. While I recognize that your committee is hearing testimony on the general subject of the federal estate and gift taxes, it is the purpose of my testimony to set forth the Association postion on increasing the exemption for purposes of the federal estate tax. Let me spend just a moment with you setting the stage for the position which our Association takes on this legislation. All of you~ are familiar with the great size of the State of Texas. You are also familiar with the fact that there are many individual property owners within our state, and our farms and ranches vary in size from several acres to many thousands of acres. Many of our people work a lifetime to pay for a farm or ranch which they have PAGENO="0638" 624 purchased only to get it paid for near the time of that person's death, but the cherished thought of being able to leave some real and tangible property to their children is foremost in their minds With the tremendously increased values on real property and the severe reduction of income from the sale of agricultural or livestock products many citizens of Texas who die leave their c~state and heirs faced with the burden of trying to carry forward the intentions of the deceased by maintaining ownership of the land within the family, but finding it impossible to do so because of the tremendous burden placed upon them by the federal estate tax. The Internal Revenue Code of 1954 relating to the exemption for purposes of the federal estate tax provides for a $6000000 exemption Without taking into account the Increased value of real property from 1954 to 1976 but con sidering the increase in the consumer price index since 1954, we find an in- crease in services totaling 136 percent and in commodities totaling 823 per cent and an overall increase of 978 percent or approximately a 100 percent increase in the consumer price index during these 21 years Since 1946 oper ating costs for pickups tractors fuel and operhtion have increased by 308 percent while beef is bringing less now than in 1946 according to the Live stock Market Digest It is our Association s position that it is time for the Congress to recognlhe that the $60,000.00 exemption in the 1954 code does not properly reflect an exemption for 1976 and future decades but that the $20000000 provided in H.R. 1793 is much more realistic and we wholeheartedly endorse the increase of the exemption to this level. We recognize that the increase in this exemption will result in a substan tial tax reduction to the Treasury of the United States however it is our judgment that the principle of individual ownership of land is one of the basic principles upon which our country was founded and no tax imposed by our government should be so severe as to prevent the reasonable ownership of property Many of our forefathers made their living from the soil and the land and the importance of the agricultural and livestock industry to the commerce of the United States cannOt be over emphasized. Its importance in achieving and maintaining the balance of trade with foreign countries should be, and I am sure is of parimount concern to each of you. Without the type of relief provided by legislation such as this, many small producers will be driven from the land and instead of the strength of our country which has been derived from the multitude of people who are involved in the production process we could be faced with only large corporate producers that lack the individual identity and genuine concern and patriotism for this great United States, I would urge on behalf of the Independent Cattlemen's Association of Texas your favorable consideration of H.R. 1793. Thank you for your time and attention. Mr BURLESON All right, Mr Pottberg, we will hear from you STATEMENT OF ALRIC POTTBERG Mr. POTTBERG. Thank you. Gentlemen of the committee, my name is Airic Pottberg. I am a Florida rancher. I am a member of the Florida Sierra Club, the Ecology and Environment Committee of the Florida Cattlemen's Association, the Florida Agricultural Tax Council, and the Florida Agricultural Water Council All of these have expressed in one form or another hope that open lands, or agricultural lands, might be granted relief from execution by lethal estate taxes. I cannot read them all; some will be in the record. The Florida Sierra Club says: This will authorize you to present to Congress our view that Federal gift and estate tax law should encourage, rather than discourage, the preservation of open space. Florida Citrus Mutual says: You are specifically authorized to re- late the support of Florida Citrus Mutual's more than 15,500 citrus PAGENO="0639" 625 grower members; and asks me to express to you gentlemen appreci- ation for your consideration of modifications of estate tax law as indicated in copies of their resolution sent to you, and in the records of this committee. It is axiomatic, that in the long run, to tax a low income source with a high income source tax is to destroy the low income source. This tax destruction is what is happening today to privately held American open space land. When a farm-ranch family experiences a death, their land must pay an estate tax based, not on present ability to pay, but on speculative income from a potential higher income use of the lands. Of course, this high income tax often forces the low income farmer- rancher family to sell the land to get the money to pay the tax. When this happens, the land must go into the higher income use by which Treasury appraises it. Agriculture, or open-space-use lower income, cannot justify expenditure of the high price which Treasury de- mands the seller must get. The new owner is economically forced to be a destroyer of the open space. Not only are our visible open spaces being destroyed by this high income source tax, but at the same time we are destroying our abundant inexpensive food source to create less abundant expensive food. At the same blow we are destroying the private farmer-rancher family which, because of an emotional attachment to the land and way of life, chooses to remain a relatively poor farm family rather than a rich former farm family. No effective custodian of the land is replacing him; in fact, the new custodian produces a rape of the land. Open space also provides the clean water man must have to live. Rain is filtered through the sand into the ground aquifer, from which it is taken as needed by man for crops or town uses. When rain falls in town it is wasted, it runs from dirty paved surfaces to gutters, to drains, to sewers, to the salt water where it is lost. Open space is the recharge area for the water we must have. Open spaces provide the habitat in which our wildlife can still exist, in man's world, helping to bring happiness and necessary en- vironmental balance to that world. So we see a tax which destroys open space, destroys also cheap food, destroys social harmony, destroys our economy, and destroys the private farmer-rancher family. It destroys our clean air, destroys our clean water, destroys our wildlife, and destroys our lives. Agriculture cannot pay the estate tax to maintain open land close to towns, although it is in these areas that open spaces are most esthetically desirable. Private preservation of larger open spaces, of course, enables it to be available for later public ownership, if that. is considered desirable. For many it is already too late. For example, a fellow rancher on the FCA land use committee, with which and with whom my ~wn committee sometimes sits in joint session, was having to sell a 7,000- acre tract for estate tax payment that he and his Dad had tried to keep as wild as possible. When I last spoke to Pat Corrigan there were 126 Osprey nests on the river flowing through that tract. With its new capitalization basis, of course, today, those Ospreys and that PAGENO="0640" 626 relatively wild and clean river are doomed, just as the Pithlachascotee River through Pottberg Ranches is almost certainly doomed. My counsel, Ron McCall, sitting here with me, and I, visited my 93 year old bachelor Uncle at his home a couple of days before we came to Washington to talk to you I have to tell you now that I believe that no matter how fast this effort proceeds, Pottberg Ranches will probably serve as one more example of the fact that the appli cation of a high income tax to a low income openspace will destroy that open space Like Pat, who told me he felt as if he had been told to cut off his left leg, I, too, am deeply disturbed by the impendrng rape of the land which has been my work, my charge, my child I didn't come here, however, to say to you, "Save Pottberg Ranches" I did come to say that every day Congress procrastinates another water and air and food and wildlife and beauty producing `ii ea 1S becoming another corpse-with its erstwhile custodian Thank you, gentlemen, for your time and attention If there `ire questions I shall try to answer them I have in my pocket a couple more telegrams from Florida orga nizations which arrived in support of my position this morning and too late to put in the record One is from the agricultural tax coun cr1, which is signed by an executive vice president of the Florida Dairymen's Association, and one from the Florida Cattlemen's Asso ciation Mr BtTRLLSON Do you care to enter them in the record ~ If so, that will be done without objection [The telegrams follows 1 [Telegram] FLORIDA AGRICULTURAL TAX COUNCIL Orlando Fla March 15 1796 RICHARD POTTBERG Washington Hotel Washington D U It was moved by Porn MeClane and seconded by Bob Pittrnan that the Florida Agricultural Tax Council is in complete accord with the general philosophy of the Burleson bill in the U S House of Representatives which seeks to increase the personal and widows exemption from estate taxes and which would allow farms passing from one generation to the next to be valued at their agricultural use value for estate tax purposes W R BOARDMAN Executive Vice Pres*ient Dairy Farmers Inc FLORIDA CATTLEMEN S ASSOCIATION Kissimmie Fla March 15 1976 RICK POTTBERG, Washington Hotel, Washington, D.C. This will authorize you to present to the Congress of the United States our view that Federal estate and gift tax law should encourage rather than dis courage preservation of open spaces resolution of FCA board of directors dated 9-18-75 whereas there are several bills in Congress designed to aid in a fair and equitable adjustment of estate taxes based on agricultural value Now therefore be it resolved that the Florida Cattlemen s Association go on record as strongly supporting such bills and Representatives give their full support to the passage of such bills JIM MUMMEY, Executive Vice Presi~lent. PAGENO="0641" Airic C. Pottberg, a Florida rancher, in a fast-growing area, has seen the effect of the present estate tax on family farmers and ranchers, tile loss of open areas to the public, the loss of beautiful trees, foliage and the injury to wildlife, and tile rapid reduction of Florida's most important natural resource -water. A continuation of the present estate tax would endanger these natural resources, and perhaps remove a most valuable asset which is important ill inaintaiiiing the present quality of air *at a time when industrial progress is causing the dumping of huge amounts of pollution into the air. Farm units should be preserved. The preseiit law results in injury to society by tile loss of agricultural units that produce food abundantly at reasonable prices. The public generally will gain from a change in the estate tax law so that agri- cultural land will be assessed at its value for agricultural use. Tile family can then keep it in agriculture. INTRODUCTION I ~m Alric C. Pottberg, President of Pottberg Ranches, an agricultural cor- poration, owning land ill Florida in a fast-growth area. As a cattleman, I am dedicated to preservation of agricultural units. I am known as one who is ill favor of preservation of natural resources and the environment. I am a member of the Florida Agricultural Tax Council, Agricultural Water Council of Florida, Florida Citrus Mutual, Florida Cattlemen's Association and Sierra Club (Florida Chapter).. These groups have encouraged me to speak In favor of changing the estate tax law to enable farmei-s and ranchers to maintain agricultural units, to the benefit of the public. I have resolutions and endorse- ments from the following Florida organizations: Florida Agricultural Water Council, Florida Chapter Siei-ra Club, Florida Citrus Mutual, Florida Agri- cultural Tax Council and Florida Cattlemen's Association. Copies of these resolutions and endorsements are attached hereto as Exhibits 1, 2 and 3. I. FARMERS, RANCHERS AND OWNERS OF OPEN SPACES GENERALLY ARE INJURED BY REASON OF THE PRESENT ESTATE TAX LAW AND THE REGULATIONS AND POLICIE5 OF TIlE INTERNAL REVENUE SERVICE BASED UPON THOSE LAWS The problem is that many of today's farmers and ranchers cannot pay estate taxes based upon values determined on the 50 called highest and best use. Farmers make a limited amount of money from farming or ranching and be- cause of that these farmers and ranchers do not have the opportunity from their income to amass large sums of money with which they would have cash on hand to pay huge estate taxes. If they had been using the land intensively, their income would be greater by large proportions. They would then have accumulated sums sufficient to pay estate taxes based upon valuations of land at intensified uses from profits. They could do that `and still keep the land, but only if they had made an intensified use of it. Recently, I talked to a man in my area who had been contacted by the Internal Revenue Service, and during the course of his conversation had been told that all land in our area of the State of Florida should be considered for intensified u'se and development. The policy of `the Interilal Revenue Serv- ice apparently is that without regard to the fact that the property has been used for agricultural purposes, for decades, that the land will be appraised under the present law at ndn-agricultura.l values and would be appraised at 68-872 0 - 76 - 41 627 Mr POTTBERc I'hank you, sir That conclii~'os my statement, and I thank you foi youi time and attention Mr BTJRLLSON Mr McCall, do you have an additional statement ~ Mr MCCALL We would like for his printed statement to be made a part of the record Mr. BURLESON. Without objection his full statement will be in- cluded in the record [The prepared statement and attachments follow ] SIATEMENT OF ALRIC C POTTBERG FLORIDA CATTLEMEN s ASSOCIAIION SUMMARY PAGENO="0642" 628 such a high rate that the farmer would need to sell the property simply to being a position to pay taxes upon it. I have a friend, Joe Barthie, whom I understand had to sell his ranch in order to pay estate taxes. The land wa~ not really ready for higher use or intensified development but because of the valuation of it by the Intenial Revenue Service, there was no way that lie could have paid the estate taxes other than by selling the land to a speculator. The only person who is in a position to pay the higher price for the land is a speculator who either will instantly develop the property into comniunities such as we have in Florida in many places, or will hold the property for some period of time and then develop it. Bedroom communities spring up fast in Florida. Agi~icultural lands change over night, it seems to me. I have another friend, Jim Williams, who lives on the land. For as long as I can remember, lie has farmed at least a forty-acre patch and lie wants to continue to do that. His expression to me the other day I think typifies the feeling farmers and ranchers have about the land. He is 78 years of age and when the weather permits and when the land needs it, lie always works on that 40 acres. His wife suggested recently that lie stop working the 40 acres because after all, lie is 78 years old and lie said, ~Jf I didn't have the land to farm, what would I do ?" Farmers and ranchers never want to give up their land. His feelings typify the feelings of ranchers and farmers who are tied closely to the land, and want to keep it intact for farming or ranching purposes and want to have it available for their own families' children or grand- children in the future. The estate taxes are injuring these farmers and ranchers by requiring them to give up the land to pay the taxes. For Jim Williams, if lie gave up the land, there would be nothing else for him because that is the central point in his life and that is what keeps him going (lay after day even at the age of 78. The State of Florida is an example of what can happen in a fast-growilig area. As indicated by a recent publication, a copy of which is attached as Exhibit 4, Florida's population increased from 4,951,560 to 8,517,100 between the years 1960 and 1975, and 75% of the State's population is located on 27.6% of the land. Land used for agricultural purposes in Florida, if purchased for agricultural use may not receive favorable Green Belt local tax treatment where the pur- chase price exceeds three times the agricultural assessment on the property, as shown by a copy of the newspaper article attached and made a part hereof as Exhibit 5. This fact has precluded one county in Florida from allowing future agricultural owners the ability to obtain favorable local tax treatment. The present estate tax causes many agricultural families not to be able to continue with their agricultural unit because of the high estate taxes. The State of Florida has recognized the importance of preserving agricultural lands and the need for future estate tax reform, as disclosed by a copy of the State Compre- hensive Plan attached hereto as Exhibit 6. II. WATER IS FLORIDA'S MOST VALUABLE NATURAL RESOURCE AND IT IS BEING DEPLETED BY URBANIZATION Florida's most valuable resource Is water. Without water Florida could not continue to exist `and grow. It is one of the nation's fastest growing states. I live in an area commonly referred to as the Gulf Coast Area of Florida encom- passing Pinellas, Pasco and ililisborough Counties. These areas are having water problems due to fast growth at a rate so great that existing facilities have difficulty keeping up with day to day needs. Water shortages have existed. Actions have had to be taken by local communities to limit the use of water. Water is important to agriculture as well as to industry and the public. Water is important to everyone. In order to assure communities of continued water resources, large areas of land have to be maintained freely in open spaces. Many of these large areas of open space lands are owned by farmers, ranchers, and others. When large cities need water supplies, near the Gulf Coast of Florida initially they put down wells which pump fresh water. As time goes by and as needs increase, more and more water is pumped up and as it is done, the level of the water is decreased and salt water from the ocean intrudes. Salt water intrusion is one of the biggest problenis that Florida coastal properties face today. Corn- munities are having to reach out with long pipelines to areas where water can PAGENO="0643" 629 be obtained. Salt water intrusion increases in intensity in Florida each year. Salt in the water in Florida and other places is a risk of health to the commun- ities, particularly for citizens suffering from heart trouble. Our own family agricultural unit has been contacted concerning the supply of water to com- munities where their own water supplies have been the subject of salt water intrusion. This is a growing problem in Florida and most likely will hit other coastal areas as well. The maintaining of large areas of land as open spaces for agricultural use can help the situation. It is hoped that water taken from these large land areas and used in the cities eventually will be subject to processing which will allow it to be sent back to the open areas for recharging purposes. But if these open areas are not maintained and are used for intensive purposes or developed, then there is no source for water for these communities. The processing of salt water into fresh water is too expensive to be practical. Some communities have thought that they have solved their problem by con- structing well fields. But I know of one area in Florida, the Eldredge Wilde Well Fields, where there is patently too much water being extracted so that the "cone of depression" extends outward eight miles, as shown in the attached copy of an article, marked Exhibit 7, from the Tampa Tribune dated August 5, 1973. Six areas in the Tampa Bay megalopolis have salt water intrusion problems, as shown by the copy of an article from the Pasco Press attached hereto as Exhibit 8 in which it is noted that the City of New Port Richey closed several wells when five of nine wells contained chloride in excess of public health standards. Even rivers such as the Pithiachascotee suffer by reason of salt water movement upstream. Virtually all of the peninsular and downtown Tampa area have been engulfed in a zone of encroachment believed inching northward. The problems in Florida forecast the problems that will come in some other areas as there Is a continued drawing down of surface water. Florida is a show- case of what is happening all over the country. The harm done by condemning open space In the cities to development, in order to pay estate taxes based on its consequently exaggerated value, is particularly remarkable in the case of water; obviously the one resource beside land and air crjtical to life. When the open space needed to supply ground water is inhabited, paved over and roofed over, it becomes only a water consuming instead of a water producing area; the effect of its conversion on the water supply is, in effect, doubled. Excessive use of water effects the land and those dependent upon it and can lead to the dying of gram, trees and shrubbery, and a lack of water supply for cattle and wildlife. The availability of large land areas for water sources can prevent the excessive use of water and the excessive taking of water from one particular area. What governmental units should do is spread out the taking of water from their communities so as to take some water from different land areas. But if these different land areas have been taken up in development or industrial use, the communities do not have that choice available. It is important for large agricultural and open spaces to be ready and available to permit the use of this water. Development or intensified use of the land reduces the avail- ability of water resources. The present tax policy encourages the development and intensified usage of property that otherwise could be available for future water resources. Salt water intrusion can irreparably harm and injure com- munities. If agricultural units are allowed to continue to exist, without having to be sold to pay estate taxes, this problem can be diminished and eventually solved. III. THE ESTABLISHMENT AND CONTINUANCE OF AGRICULTURAL, FAEMI$G AND OPEN SPACES IS NECESSARY TO CONTINUE TO PROVIDE FOR CLEAN AIR AND THE EXISTENCE OF WILDLIFE AND OTHER NAVURAL RESOURCES We have all heard about the condition and quality of our air. Florida is not unlike many other states. Some areas of the States have pollution problems. Clean air can be improved by the presence of open areas where farming and other agricultural operations are being conducted. Air is "cleaned" as a result of the photosynthetic process in trees and shrubs and wild plants as well as cultivated crops. However, with an intensified use of land, as distinguished from an agricultural use, trees and crops will disappear at a time when they are needed, not only because of our food problems but because of our air problems. PAGENO="0644" 630 These open spaces act, in fact, as clean air generators. The absence of large open spaces can affect the quality of the air. Poor air quality can result in respiratory diseases and unhappy lives for those who have them. Air pollution problems would be eveii greater now except that we do have a substantial number of large open spaces and agricultural units in operation. As population steadily increases, the need to assure our supply of natural wildlife increases. Wildlife can exist on agricultural areas and open areas but intensified usage can drive them away, causing them to disappear and not be available for future generations. On our land we have deer. I hope never to have a time when the deer would be endangered. But if the present estate tax is not changed and land must be sold to pay taxes, the most likely purchaser of land would be a developer who would have to make an intensified use of the property either at the present time or in the near future to justify the payment of the price. Wildlife should be preserved for the future as an asset of our country. The natural beauty of the land, forests, and streams is emphasized by the presence there of wildlife such as deer. The continued encroachment upon these areas by further development is causing not only a reduction in the wildlife but a complete removal of certain species, or at least a substantial reduction of them. As a member of the Sierra Club, I am concerned about the preservation of the environment, for ourselves and future generations. Estate tax reform can lead the way in assuring future generations of the beauty of the outdoors and the presence of wildlife. No amount of money can produce the pleasure of seeing a deer walking through the woods breaking the leaves as the dew glistens. But how to you tell a deer the land will be changed? How do you replace the birds that are missing? How do you protect the birds that are present? How do you protect future generations? IV. THE PRESENT TAX LAW CAUSES RANCHERS AND FARMERS TO SELL LAND TO WHICH THEY HAVE EMOTIONAL ATTACHMENT. THIS REDUCES THE AMOUNT OF ACREAOE INVOLVED IN FOOD PRODUCTION, AND LEADS TO INCREASED FOOD PRICES We face a grave pr&blem in the future if our food resources are inadequate. At the present time about 5% of our people produce the food required by us. Yet at this very time, the private farmer is being driven out of farming. By the private farmer I mean the individual who farms or the family corporation or partnership that is engaged in farming or ranching activities, who is emotionally attached to the land. The farmer, with his emotional attachment to the land, tries to retain it in open spaces for agricultural use and is not prone to use the land for development, and is the only strong opposition to further development of open areas. The feeling for the land causes him to decline offers to buy the land out from under him made by speculators or developers. By forcing this private farmer to sell his land to pay estate taxes we are destroying open areas that cannot be regenerated or obtained in the future. The estate taxes are so great the surviving children or grandchildren do ~iot have present cash on hand with which to pay the taxes when the land is assessed at its highest value. Assets must be sold and what is there to sell-the land. While the land may have an intensified use value, it seldom means that using it for agricultural purposes would generate an income consistent with that value. Agricultural usage of property produces less income than an intensified use. The farmer and rancher finds this to be an intolerable position throughout the country and particularly in Florida. The effect of a continued policy such as this will mean that the people of our country will be deprived of farm and ranches and food production will be sub- stantially reduced. The recent effect upon our country of less oil brings home the realization that if there are fewer agricultural producing units food prices will increase. We will not continue to have the abundant supply of food at reasonable prices. Tax reform is necessary to have continued reasonable prices. v. SUMMARY It is obvious that the subject here being discussed Is one whose time has come; and the question Is no 1 nger "Whether", but "How". Recognition of this fact has already stimulated more than half a hundred recent, proposed formulae for PAGENO="0645" 631 reformation of existing estate tax convention. Many of these direct themselves mainly to recognition of, and solutions for, the problems created by existing law, but fail to recognize the opportunity presented to achieve some lasting and flairful social benefits of far greater social significance. Something needs to be said to put the matter in the broadest perspective. This is that, on balance, the real, central, lasting potential for benefit to society is to be found in the opportunity to control the presently explosive rate at which suburban land is being forced into development; to control it by providing an alternative to immediate sale to pay estate taxes; so that the matter of choice, not only by the owners but by government, which then has time to make con- sidered evaluations and purchase desirable areas. To the extent that suburban land, especially, is withheld from development the environmental and economic advantages to the concentrated population nearby are manifest and lasting. The cost to society of deferring or even excusing that part of the estate tax attribut- able to, and predicated on, uses to which the land is not being put is insignificant -twenty million! 1 All agricultural units should be included, whether small, medium or large farm or ranch operations. If there is an immediate and predictable obstacle to achievement of these maximum goals it may lie in concern on the part of some about extending such tax reform to large land units, but such a concern should not be allowed to preclude the necessary changes. If it did then the present debate on this subject would turn out to be simply another political exercise, and the prospects for substantive, long term social benefit lost in deference to immediate political expediency. This danger lies in fear of rebuke for extending the effect of such legislation to include the larger farm and ranch operations. Larger tracts of land constitute a major part of the opportunity to help preserve our natural resources. They are sought by the developer. The large operations are most jeopardized by present tax convention (because their theoretical value places them in higher estate tax brackets). They constitute the main prospect for aesthetic and environmental stability, and they are the areas large enough to support meaningful agricultural businesses at the edges of the cities. If this fear prevails the present debate will have been, simply, another political exer- cise, in which the most exciting prospects for far reaching, long term social benefits are buried in deference to immediate political considerations. The assets of an agricultural unit should be treated the same without regard to whether the ownership is in a person, firm, corporation or trust and without respect to whether it is small, medium or large in its operations. There should be no restrictions placed upon the nature of the income. The sole question should be whether the land or the unit is a trade or business engaged in agriculture. If it is a trade or business it should not be afi~ected by some arbitrary requirement that a percent of its income be specifically from agriculture. Rental income should qualify as does other income. Internal family gifts or other transfers should be encouraged as a division of ownership without effecting a change in ownership. The public need for a change is certainly present. You can save farmers and ranchers from losing their land, preserve natural resources and the environment, and keep reasonable food prices by reforming the Estate Tax Law. The present tax hurts ranchers and farmers and the public. The tax is unfair and destructive. It must be changed. I thank you very much. FLORIDA AORI~ULTURAL WATRR COUNCIL Co., Leesburg, Fla., March 15, 1976. ALRIC POTTBERG, Hotel Wash4ngton, Washington, D.C. You are hereby authorized to represent the Florida Agricultural Water Council with respect to the hearing on Federal estate and gift taxes law. The councils position is: 1. Land used for bona fide agricultural uses should be appraised for its agricultural value and not at the highest and best use. 2. The estate tax exemption should be increased to amounts reflecting present day value. 1 Congressional Committee on Ways and Means, U.S. Rouse of Representatives, Back- ground Materials on Estate and Gift Tawation 62 (March 8, 1976). PAGENO="0646" 632 This action will encourage maintaining present agricultural property in agricul- tural use and will not necessitate forced selling of family farms to pay estate taxes. ELTON CLEMMONS Chairman FLORIDA CHAPTER SIEnnA CLUB Tallahassee, Fla., March 14, 1976. ALiuc P0TmERG Washington Hotel, Washington D C This will authorize you to present to Congress our view that Federal gift and estate tax law should encourage rather than discourage the preservation of open space. CASFIY GLUCKMAN. FLORIDA CITRUS MUTUAL, Lakeland Fla March 11 1976 Mr RICK POTTBERG Hudson Pta DEAR MR POTTBERG Attached is a copy of a resolution passed by our Board of Directors on March 10th We would very much appreciate it if you would present this directly to the Ways and Means Committee when you are in Washington next week Express our appreciation for the consideration of this problem and our wholehearted support in making the modifications which are suggested here You are specifically authorized to relate the support of Florida Citrus Mutual s more than 15 500 citrus grower members Ihank you fo" your cooperation in this matter Sincerely, ToM OSBORNE, Iikvecutive Vice President Enclosure. RESOLUTION Whereas the United States Congress is currently considering modification in estate and gift tax proposals and Whereas, the estate tax exemption has not been increased during the past twenty-five years,' and Whereas agricultural land for estate purposes is valued at highest and best use rather than as agricultural land and Whereas in practice the application of current law and regulations make it extremely difficult for family farms to remain in the hands of the family fol lowing the death of each generation be it hereby Resolved by the Board of Dsre~tors of Florida Citrus Mutual at its regular meeting on March 10 1976 in Lakeland Florida That 1 The modification of current estate tax lass and regulation is the only way to assure the maintenance of family farms and therefore 2 The Congress be requested to increase the exemption on estate taxes and 3. The Congress be requested to require that agricultural lands be valued on the basis of their use as agricultural lands and not on a highest and best use basis, and 4. Copies of this resolution be forwarded to the Honorable Al Ullman, Chair- man of the Committee on Ways and Means, United States House of Repre- sentatives, to all members of that Committee and to the entire Florida Con- gressional Delegation. FRANK Bouis, President Attest: CHARLES C PARTIN Secretary. PAGENO="0647" 633 [From the Pelican Papers, February 1976] DRAFT STATE LAND DEVELOPMENT PLAN ISSUED We recently received a draft copy of the "State of Florida, Land Develop- ment Plan." The introduction says in part: Development in the state has occurred and continues to oecur without benefit of an overall management strategy. Failure to recognize opportunities for and constraints to development provided by land and related resources has resulted in unwise expenditures of fiscal and natural resources by government and the private sector. Between 1960 and 1975, population in the state increased from 4,951,560 to 8,517,100. During the early 1970's the state's population increased at a rate of approximately 24,000 per month. Florida's population Is estimated to be 9,945,700 by 1980 and 14,558,300, by the year 2000. Presently, 75% of the state's population is located on only 27.6% of the land area of the state, the coastal zone (See Figure 2). As well as being the most attractive area to new residents, the coastal zone is the most sensitive to development. Within the last 20 years, the coastal resources have suffered abuse to the extent that much of the beauty of the state has diminished. But more importantly, the capability of the coastal zone to support coninued, unmanaged growth no longer exists. There are approximately 27,059 square miles of upland areas in the state which are generally well drained and contain sufficient natural resources to support growth and development. Copies of the Plan are available from Helge Swanson, Chief, Bureau of Com- prehensive Planning, 660 Apalachee Pkwy., Tallahassee 32304. [From the City And State, Tampa, 13'lorida, Oct. 26, 1975] `GREENBELT' EXEMPTION TIGHTENED (By Mary Anne Corpin) More than half the people who applied for greenbelt exemptions on newly purchased property in Hilisborough County this year didn't get the special tax exemption. "Greenbelt" means the difference between paying taxes based on, say $125 an acre appraisal on improved pasture, and the taxes on an appraisal of $1,554 an ~tcre, such as one young couple faces because they couldn't get greenbeit on their new, 40-acre farm. "Without greenbelt," said Farm Bureau Executive Director Betty Jo Tomp- kins, "agriculture couldn't survive in this state. If farms were taxed at `fair market value,' it would put the farmers out of business. "But we don't want the greénbelt abused. The abuse comes in, Property Appraiser Bob Walden said, when someone wants to live in the country, buys five acres, builds. a house, brings in two or three cows, and says, "I'm a farmer." "They just don't meet the requirements of the law," Walden said. "We get quite a few of these-I wouldn't even guess at the number." Some contend that the abuse also exists when city dwellers own untouched palmetto land for specuiation, but who nonetheless have greenbeit exemptions. In trying to avoid the abuse, the county "has to draw a fine line" in determin- ing whether some cases qualify for greenbelt, Walden admitted, tracing an imaginary line on a map for emphasis. The county received 625 new applications for greenbelt exemption this year, Walden said. Appraisers from his office denied greenbeit to 357 of these applications, or 57 per cent of the total, and approved the other 269. About 7,000 greenbelt exemptions from previous years were renewed, but 196 of the old exemptions were denied. More than 60 people who were denied greenbelt are appealing to the county's Tax Adjustment Board. Some are getting the exemption. Some aren't. Some of the board's members think it's "a waste of time." PAGENO="0648" 634 When we have overruled the tax assessor s (property appraiser s) judgment on it (the greenbelt law) the Department of Revenue (the state s tax depart m~nt) has overruled us," said Mrs. Pat Frank, one of the five county school board members who rotate on the tax board. County Commissioner Betty Castor told the county's legislative delegation a few days ago that it's almost impossible to buy farm land at a price which will allow for a greenbelt exemption. "The law presumes that if you purchase land for more than three times the amount of the appraised value, that's cause for losing greenbelt," Commissioner Castor said. "Many people who want to have a bonn fide agricultural operation in this county today can't. There s hardly a place in Hillsborough County where you could purchase property that wouldn't be more than three times: the current assessed value." The agricultural assessment varies, according to the type of farm, Walden said. For instance, lie explained, row crops have a $250 per acre assessment (which means a buyer could pay $750 an acre and not be suspect). Orange grove land is appraised at $400 an acre, hay fields at $250, native pasture at $40 to $60, and a hog farm at $450 an acre. "If anyone pays more than three times the agricultural assessment allowed, then we're to question if it's a bona fide agricultural, use," Walden said. Is thei e any land that sells for these low prices in Hillsborough County ~? "Not any more,' Walden said. He later revised this to say some land "sells for $600 to $700 an acre out in the pastures Compared to prices in most of the county, he said, "you can find property a lot more reasonable at the south end (in the Ruskin area) ." The appraisal prices "don't give much latitude," Mr. Frank said. "It precludes a small person frc~m being able to go into any agricultural enter- prise," the school board member told the county's legislators. She said a large co-operative can get *a better per-acre price on 100 acres than can the small person buying 10 acres. "It's a bad situation," Farm Bureau Director Tompkins said. "The cost of going into agriculture continues to i ise It has reached the point at which you must inherit a farm or marry into it or you ye just got to luck out somehow "Most of the people who lend to agriculture will tell you that to get into farming today, you have to have a lot of capital behind you, some good strong backing Mrs Tompkins said Most young farmers are working in a family operation with other relatives as partners Otherwise it s very hard to get into it, and it gets harder all the time." PAGENO="0649" POLICY J-7: Child Care: The physical standards for child care ceritersshould be reassessed on a more practical basis, for the purpose of increasing the availability of day-care centers operated by non- profit agencies for rural low-income, farm workers' families. * . POLICY J-8: Child Labor: There should be a rigorous enforcement oT raT and state child labor laws. . POLICYJ-9: State Housing Authority: A statehousing authority shoiiid be created to facilitate the construc- tion of decent housing for farmworkers and other low- income groups. OBJECTIVE L-I: Preservation of Agriculturalj~ds: To prevent further despollatioii and harm to Florida's re- newable resource lands through unregulated dev~eloprnent, the state shall embark upon a program to identify and preserve agr~cultural lands With special emphasis upon those agricultural lands most seriously threatened by urban development, government, or other forces. . . POLICY L-1: Definition of Agricultural Lands: The State of Florida should adopt the f~TTawing definition of agricultural lands. * , . POLICY L-2: ~ppjpg of Agricultural Lands: In order to properly consider the soil in both agricultural planning and development, Florida's 10-year statewide soil survey mission should be continued with increased priority given to rapidly urbanizing counties with agricultural, environmental and other renewable re- source lands. POLICY L-3: SoilsConsider~tion: All planning and developmentalactivities affecting Florida's lands must explicitly consider the protection of the natural qualities of the land and water and the * . . , capabilities and needs of the soils so as to dis- courage and discontinue soil wastage and soil erosion. POLICY L-4: Agricultural Impact Statiments: Agridul~ tural lands are ess~ntial, renewable resources of our environment which shall be dealt with in environmental and socio-economic impact statements. * . - OBJECTIVE L-II: Tax Laws and Policies: Existing tax laws and policies~IE~ifl levels of government should encourage the preservation of agricultural land. . POLICY L-5: Federal Estat~Ta~~: Changes in federal estate tax laws should b~ made so that agricultural land nay be valued at its value as farm land as long as it remains in agriculture, and the estate tax exemption should be raised to a more realistic present-day level. . [From the Tampa TrIbune-Times, Aug. 5, 11P73] PINELLAS PUMPING AFFECTS AQUIFER Ur To 8 MILES (By James Walker) Southwest Florida Water Management officials yesterday disclosed maps and pumping figures that show the three big weilfields In Northwest Hlllsborough have overlapping Impact that reaches as far as eight miles from the welihead. Most, in fact, of the northwest county, can measnre some water drawdown in the Florida aquifer because of the cones of depression from the fields. The SWFWMD figures apply to the `aquifer, which In instances is hundreds of feet below ground surface, and don't directly measure the "surficial" aquifer, tine ground water that lies close to surface. 635 OEFARTE~ENT OF AOMtNISTRA1~ON DIVISON OP STATE PLANNING ~FM1TetJtfW~ OEPAATMEN1 OF AGFIICULTURE& CONSUMEP SEEVICES AGRICULTURE ELEMENT of the STATE COMPREHENSIVE PLAN q PAGENO="0650" 636 But Derill McAteer, chairman of the SWFWMD governing board, said, "We consider it (water) as a unit. When the aquifer is pumped down, the surficial sands drain water to it faster." A clay layer lies between the surface water table in the sands and the deeper Floridan floodway which flows through porous limerock, but leaks and gaps in the clay provide troughs to drain the upper water as the aquifer drops. "We think that as far as 2.5 miles out from each wellfleld, there is a definite influence" on the water table, McAteer said. "I think that in the case of the Section 21 wellfield, it has caused definite damage to surrounding lakes." McAteer asked the SWFWMD to prepare the data in hopes the northwest county residents can be more helpful in giving witness to the need for pumping regulations. Too often, he indicated, a property owner will complain of dropped water capacity on his property, then either blame `the wrong weilfield or misidentify its owner. The major fields in northwest Hilisborough are St. Petersburg's Section 21 and Cosme fields. Just across the Pasco line, the City of St. Petersburg has opened its Pasco field. The County of Pinellas operates the Eldridge-Wilde field on the Hillsborough, Pinellas, Pasco county lines. SWFWMD also supplied pumping figures for the fields for June, the month of historic record, on which the impact to the aquifer was' estimated. Section 21 pumped 23.1 million gallons per day; Cosme some 101 million gallons; and the Eldridge-Wilde some 44.7 million gallons per day. Based on these pumpages, Section 21 caused a drawdown in the aquifer of 10 feet at a distance one mile from wellhead, a five feet drawdown 12,500 feet from the well and zero impact only beyond 40,000 feet (nearly eight miles) from the wellhead. The Cosme field, which SWFWMD moved to curtail pumping on first because of its critical harm to nearby lakes, showed the least impact in June. At one mile from the wellhead, it caused a drawdown in the aquifer of 4.5 feet, and at eight miles from the wellhead, the aquifer drawdown was less than half a foot. Eldridge-Wilde shows the colossal figures. Pumping at the June rate of 44.7 million gallons per day, the aquifer draw- down was some 19 feet a mile distant from the weliheads; at two and a half miles from the wells, the drawdown was 8.5 feet; and at 40,000 feet from the wells, the drawdown was registering about a foot and a half. This corresponds, SWFWMD officials indicate, with data which shows Pinellas County is actually pumping below sea level in some wells in the field, creating a big cone of depression. The normal potentio'metric surf ace at the Eldridge field is some 20 feet above sea level. SWFWMD is proposing to curb Pinellas from pumping more than 28 million gallons per day from Eldriclge-Wilde, but with provisos it might take more during heavy rains. McAteer currently is negotiating with Merritt Stierheim, Pinellas County manager, for stipulations on operation of the field to avoid court battle. St. Petersburg city officials have agreed to pumping regulations which SWFWMD staff believe will restore the fields and lessen the drawdown impact. PAGENO="0651" 637 Monitoring of water table levels would provide a proposed means of regulat- ing the well field operations. District hydrologists, however, have concluded that `the water table cannot be used effectively as a regulatory index, because of natural variations. The almost instantaneous effect of rainfall on the water table and the time lag between pumpage from the deep Floridian aquifer and its effect on the water table makes the method discussed at the last public hearing far too cumber- some, according to the district hydrologists. District hydrologists have expressed concern over the salt water intrusion zone which affects the Tampa Bay and Pasco County areas. Senior scientist and chief hydrologist Gerald G. Parker says that with recognition of the serious salt intrusion problems, corrective `action can be taken. Improvements that can be done include: Salt water harriers in channels and rivers, water conservation projects, well field regulations and rules designed to prevent further lowering of the aquifer. Florida's aquifer, a volume of underground fresh water, is only one source of water `supply for the `state, the district publication "Hydroscope" points out this month. There is `also the source of Florida's springs that have a combined flow six times greater than all the public water systems in the state, according to a just-released report from the U.S. Geological Survey. The combined flow of Florida's springs is five billion gallons per day (8,000 cubic feet per second), according to the report, "An Index to Springs of Florida." It identifies the magnitude of 165 springs and seven pseudosprings and specific data on water quality, discharge and temperature is given for 22 first-magni- tude springs (those discharging more than 100 cubic feet per second). Authors of the report, Jack Rosenan and Glen Faulkner, say that the water of most Florida springs is of excellent quality, low in salinity and of moderate hardness, there is a definite influence" on the water table. -Derrill McAteer, chairman of the Southwest Florida Water Management District PAGENO="0652" 638 The December 1974 issue of Hydroscope cites the federal report as offering Pasco County's Pithlachascotee River as a potential supplementary source of water supply for the fast growing west side, or as a source for recharging the Florida aquifer. In times of low flow the river is subject to 11 miles of upstream salt water movement, but upstream from the tidal action, fresh water in the river usually meets water quality standards for public water supply The report suggests that salt water barriers in the river channels would increase the fresh water zone and could be either low dams with movable gates or rubber or plastic inflatable dams. Also suggested in the report on the Pithlachascotee is diversion of a portion of the river run-off during high flow periods into temporary detention areas to induce seepage into the aquifer or into some large lakes for storage. The hydrologists content that there are two major reasons for salt water movement into inland areas. One, canalization by dredging from the Gulf or from a bay or river that is subject to tidal action invites salt water invasion Two factors are involved the drainage of fresh water the soil and the flow up the canal of salt water for contact with the soil that is being drained The second reason for the movement of the salt water into inland areas has been a lowering of pressure in the aquifer brought about by increased pumpage. An increasing population means increased demand for potable water and long- term rainfall deficiency hastens the pressure in the aquifer, increasing the movement of salt water inland. The district hydrologists have nOted six areas in the Tampa Bay megapolis where zones of salt water intrusion have been cited. The city of New Port Richey has already closed some wells because of this encroachment, and five of nine wells contained chlorides in excess of public health standards All of coastal Pasco County and northern Pinellas have zones of encroachment encompassing nearly everything west of U.s. 19 and in some places east of the traffic route. St. Petersburg's Cosme-Odessa faces a potential threat from the west and south. Virtualy all of peninsular and downtown Tampa has been engulfed in the ione of encroachment and the zone is believed gradually inching northward Because salt water is heavier, fresh water "floats" on sea or brackish water, and, in Florida the sheer volume and weight of fresh water holds salt water. The water level in the Floridian aquifer stands well above mean sea level be cause of the constant recharge of the aquifer from rainfall and the const'trit outflow and impediments that create a time lag in the flow toward sea level Mr BURLESON That concludes the discussion of the panel Are there questions among the panelists of one another ~ Mr BAFALIS I have a couple of questions What happens to open areas when farms or ranches have to be sold to pay estate taxes? Mr. POTTBERG. Well, Mr. Bafalis, I suppose that I have said too much about myself, but my own case is the one that I know the best and so I can tell you that in )ust an illustrative case which is our own, the hydrologists of the Southwest Florida Regional Water Management District have determined that it would be advantageous to the counties surrounding Pasco County in which our ranches are, to have water detainment areas along the Pithlachascotee River That flows for several miles through Pottberg lands and for the past 2 or 3 months utility people in the area have been talking to me about try- ing to draw water from under our ranches because of the constantly increasing demand for more water from the growing urban areas and the advancing salinity barrier along the coast. Just as I got up here my counsel, Mr McCall, told me that he had just had a call from the county asking about water rights under our ranches. PAGENO="0653" 639 Now, when these lands are forced by the estate tax into develop- ment, as they will be, then of course all of these water retention and recharge capabilities are destroyed and the whole community suffers. Incidentally, it might be desirable to tell you at this time that we have been informed that IRS considers our entire county to have residential potential and of course will tax all of our ranchlands on that basis, as if it were generating the income which a developer can generate from it. Mr. BAFALIS. Thank you. Let me ask one other question, and any of you can respoi~d to it. I think you have covered it partly, but again I would like you to reemphasize the importance of including corporations in what this committee does. Mr. GTJYTON. I would like to say it is quite usual to find that many family ranches are operated in corporate form and some in partner- ship form. But I think it is becoming more and more common to see a corporation conducting a family farm and ranch operation, aijd there are a number of reasons for that. Corporations provide limited liability and the ease of transferring ownerships by merely transferring shares of stock. It is usually easier to transfer shares of stock than it is to convey an undivided interest in property. So for many good and legitimate business reasons farms and ranches are going into the corporate form and we are seeing more and more of that in our own practice. In talking with Mr. McCaJ1, he has found the same thing to be true. S Mr. BAFALIS. I have no other questions. Mr. WAGGONNER. Mr. Pottberg, I guess this is a good day. I didn't expect to conclude the day finding myself very much in agreement with the Sierra Club but, nevertheless, it appears that we are going to wind up with regard to our present views on the estate taxes at the same point. It seems that we are in agreement even though we begin from a different point. We arrive at the same conclusion by going different routes and for different reasons. But I must say that I have some agreement with you basically, and specifically on this matter of valu- ation which is a serious problem. It is one that I don't know how to make that work, but you do have a problem. I am puzzled on how it is that IRS makes a determi- nation that the whole county in advance of the need to apply the estate tax concludes that an entire county is suitable for residential purposes. I don't know what they are doing in getting involved at this point in time. Can you explain that? Mr. POTTBERG. Yes, we have had two different oil companies after us to try to drill on our lands. We have turned them both down. But in one case their representative went to the IRS to find out whether this would make a difference in our assessments. He reported to us and, as a matter of fact, I think we have that communication with us that he considered the entire county to have residential poteritiaf This was a counsel for the IRS in Clearwater. Mr. WAGGONNER. Well, a little later down the line, if I know any- thing about oil exploration, they might be back with a better price and you might be tempted. PAGENO="0654" 640 Mr Brannon, in youi statement you took the position that we ought to `disallow what we are doing, `and that we ought to further iestrict for estate tax purposes the gift tax provisions of the code Exactly what are you talking about there ~ Mr BRANNON There is a good deal of literature on this topic of unification of estate and gift taxes It was discussed in the 1973 panels and in the 1969 Treasury reform proposals. The general concept is that there should be essentially the same tax imposed on property whether it is transferred by lifetime gift or at death, which means that you would increase the gift tax rate and also provide that the gift tax be included in the base as it is in the estate tax, and then you compute the death tax by taking account of all of your prior .gifts and computing the tax on the aggregate and subtracting taxes that have previously been paid, so that you pay the marginal tax rate on each gift In a complete unification pro gram it follows that death would be treated as another gift and tax accumulated on that Mr WAGGONNER Do you subscribe to that point of view Mr BRANNON I do, yes, sir Mr WAGGONNER I presume then this would include contributions before or at death to religious, charitable and educational institutions. Mr. BRANNON. Those are not subject to the gift tax now, and I wouldn't go along with that. Mr. WAGGONNER. They should be subject to the same tax? Mr. BRANNON. No, I am simply saying those gifts which you tax now and those estates which you tax now ought to be treated togethei Mr WAGGONNFR Could you tell me why if you feel that way you wouldn't feel that a contribution to a charitable, religious or educ~ tional group should not be subject to the same tax, because it could as well be done in anticipation of death to avoid taxes You are try ing to wear two shoes now. Mr. BRANNON. No, I am not. At the present time the transfer to a charity is not subject to estate tax and it is not subject to gift tax. Mr. WAGGONNER. But if we are trying to get revenue don't some of these people do it for tax avoidance purposes ~ Mr. BRANNON. I didn't say I was trying to get revenue. I said that we have now two kinds of taxes on the transfer of property between generations Without changing th~~t general structure of taxing trans feis fiom parents to children, I said I think the two transfers should be treated consistently and uniformly so that the tax should be the same whether the property is transferred at death or during the life time. We would only tax transfers to other individuals and not to char- ities Mr. WA000NNER. It seems to me that you are inconsistent if you are talking about giving to avoid taxes before or at death when you don't apply the same rationale to the taxation of the appreciated value of whatever it is that might be contributed to a religious, edu cational or charitable organization Mr BRANNON I would have some reservation on this appreciated pioperty I think that is a more difficult question and I think that involves our present failure to pick up appreciation on gifts Mr. WAGGONNER. You have reservation about that? PAGENO="0655" 641 On page 3 of your statement you make the statement that the most important problem is the failure to tax unrealized appreciation at death. Do you try to say you don't mean that? Mr. BRANNON. I tried to make a short statement, sir, and I had a limited amount of time and I did not try to cover transfers to charity which is a different topic. Mr. WA000NNER. That is the reason we have these question and answer periods to give you a chance to explain. Mr. BRANNON. The proposal in the 1969 tax reform studies specif- ically provided that appreciation contributed to charity would not be subject to this tax, as is the case with charitable contributions now. That is rather a different question than this general estate tax re- form. I say to you now that I think that it is not so clear that the right answer on that is to exempt the appreciated property going to charity. Mr. WA000NNER. If you believe that we should tax unrealized ~p- preciation at death, would you similarly take another view that it would be fair and equitable, since that is what you seek, to provide a reverse credit or deduction for depreciation? Mr. BRANNON. Yes, of course that was part of the proposal. I be- lieve that wholeheartedly, and I am honest about that. Mr. WA000NNER. In other words, if a man who has an estate or leaves an estate where there are extensive stocks and bonds, if they declined in value since acquisition or at some point in time, he ought to have a deduction or credit for that. Mr. BRANNON. Yes, sir. Mr. WAGGONNER. You say the death tax is basically a double tax. Now, you believe in the death tax because you said we should tax unrealized appreciation at death. I take a contrary point of view and I don't think that you ought ever to tax anything except real- ized gain but are you saying that you believe in double taxation? Mr. BRANNON. Yes. I notice you tax my income and then if I choose to spend this on cigarettes or alcohol, you tax it again. The particular point that I made in my statement was that you could get any given amount of progression in the tax system by tax- ing income very heavily or taxing income less heavily and, so to speak, postponing part of the income tax until death. The basic proposition I advance to you here is that whatever your view is as to how progressive the total tax system should be, you ought to really consider taking more of that progression at the time of death rather than out of income. That is, if you think the tax system is too progressive, then cut income tax rates, in effect postponing that, income tax and let the prospect that an individual would be able to use the income while he is alive provide incentive. Then I don't think it is really very im- portant that some children should grow up with silver spoons in their mouths. I think that there should be a real effort to make the opportunity more equal. Mr. WAGGONNER. It is my `observation that both of those people who live up with silver spoons in their lives spending their later years trying to spit it out and feel some sense of guilt- PAGENO="0656" 642 Mi BRANNON Then let us tax it away Mr WAGGONNER [continuing] For having been endowed with that silver spoon. You believe in double taxes and. I know I am abusing the Chair, Mr. Chairman, but you believe in double taxation and you subscribe then to paying a sales tax on an excise tax on gasoline or groceries or any of that sort of thing. That is double taxation, too. You can't believe in it in one instance and not believe it all across the board. Mr. BRANNON. That is right. Mr WAGGONNER You believe you ought to pay a tax on a tax? Mr BRANNON Well, what is involved here is that both income and wealth creation is a perpetual stream. We basically tax it at various points. You tax income when I get it and you tax income when I spend it and you tax me for owning property and you tax the in- come from the property. What I would emphasize is that you could eliminate one of these stages. We could in this country, for example, abolish all sales taxes and get the same amount of revenue by increasing income tax rates. You could have a whopping big revenue sharing plan At that point, we would be taking all of the tax from one point in this income cycle Now, I don't think that is very sensible I think you would do well to take somewhat less out of this income point and take a little more out of that at a different point, and I am saying the same thing with regard to this whole wealth accumulation process. I think that you would do better to take a little bit less out of the income stream and, in effect, let that be the accumulation that the rancher has to finally pay the estate taxes. Mr. WAGGONNER. You say what makes capitalism work is the in- centive to earn money? Mr BRANNON Yes Mr WACGONNER Now, I agree with you that that is true But, isn't it equally true to be able to keep what you earn without having it taxed away? Would you tell me how you provide for an incentive if you destroy private ownership of property and private wealth with your scheme of estate taxation? Mr. BRANNON. No; you are not thinking about my scheme, sir. Think about it this way: Some time during a man's life, this is a rich person, you will take $1 million. That is the measure of the pro- gressivity of the system, because he is rich we will tax $1 million away from him Mr WAGGONNER Just because he is rich Mr. BRANNON. Yes. Now, you can disagree with that and say it ought to be lowei or higher, and I am not arguing that point What I am asking is what is the best time to get the $1 million ~ I am saying, it would be a better system to take less of that $1 million while he is alive and more of it while he is dead. Now, if you really think $1 million is too much- Mr WAGGONNER It seems to me what you are proposing is to take tfll of it PAGENO="0657" 643 Mr. BRANNON. No; I am not. I am talking about whatever we take now; we have a progressive tax system. If you think that is too much, cut the taxes while he is alive; cut the income tax if this is too progressive. I am not arguing with you about how progressive the system should be. I am saying that with a given amount of progression, a given life- time combined tax on rich people I think you have a stronger incen- tive system if you take more of it at death and less of it during the lifetime. Mr. WA000NNER. But leave some at death? Mr. BRANNON. Leave some at death; I didn't suggest changing the rates. I made some very specific suggestions with regard to generation skipping and unification and appreciation, and I did not suggest changing the rates. Mr. WAGGONNER. Thank you, Mr. Chairman. Mr. BURLESON. Mr. Duncan, do you have any questions? Mr. DUNCAN. I have no questions; thank you, Mr. Chairman. Mr. PICKLE. I take it, Mr. Brannon, that you would not favor or do not favor the present exemption level of $60,000. If I understood you correctly, you said it was too high now. Mr. BRANNON. Subject to this specific set of recommendations that I made, that the marital reduction should be restructured so that there are more generous exemptions when property is left to people that the decedent would have been supporting if he had lived longer. Now, that is why I would like to put in an orphan exemption and expand the marital deduction. I am saying that beyond that when you talk about granting the bequests to grown children like myself there is no reason why I should get $60,000 without any tax on it. Mr. PICKLE. My point is that you would not have favored this law in 1942, had you had a chance to vote on it, because it was a bad law. You think it shouldn't be expanded at all and I guess that it where we would differ. If at that time $60,000 was considered a reasonable amount to opel- ate this estate tax, then we are faced with a problem: Is it still a reasonable sum? Now, if we would agree wi1~h you that it should never have been, you would have to accept that. That would be the end of the debate. But that is not our question. Our question is: At what level do we. raise the exemption to keep it in line with inflation and other fac- tors? Mr. BRANNON. You have to remember that the marital reduction was enacted in 1948, which was after the decision to enact the $60,000 exemption. It does seem to me that the marital deduction deals with a great deal of this reason for making some mistake that transfers tax free. The only other one, as I said, is this problem of surviving orphans, since it is unfair to create that deduction because we didn't have the marital deduction. Mr. PICKLE. I think I disagree wjth you on that because we are not thinking so much about the marital deduction now as we are the fact 68-872 0 - 76 - 42 PAGENO="0658" 644 that we set up the $60,000 in 1942 Now we either increase it oi we do something else Mi BRANNON It was to do the things that later we did with the marital Mr. PICKLE. You mentioned $4,000 for an orphan. Where do you get the figure ~ Is this just an arbitrary amount ~ Mr. BRANNON. I think a rather generous annual support cost. I would multiply that 4,000 by the difference between the orphan's age and 21 If the parent died at 1'S years of age, that is 6 years of main tenance and highei education and figuiing something like $4,000 t year. Mr. PICKLE. My question was: Is the $4,000 just an arbitrary figure? Mr BRANNON Yes Mr PICKLE Thank you Mr. BTJRLESON. Mr. Jacobs, do you have a question? Mr JACOBS As I understand the present estate tax, when a de cedent leaves a piece of property, say the decedent purchased it foi $100,000 and depreciated that down to $5. The person who inherits that property, so far as Federal estate taxes are concerned and so far as Fedeial income tax is concerned, is given a new basis of maiket value of the property That is an obstacle against which refoimers normally speak My question to any members of the panel would be this What if you gave the legatee the basis of the testatoi foi capital gains purposes and also for estate tax purposes, the same valuation ~ I would like obviously to hear Mr Brannon's comments about it, but I also would like to hear the other side. So, would the panel choose up sides or chew that one a moment ~ Mr CUNNINGHAM I would like to add that it costs $11/2 billion to raise the exemption from $60,000 to $200,000. The incentive alone will bring that back more than 10 times There is just no doubt to the people I represent that it would change it Everyone has to use their own personal thing to birng this out I worked 27 years to buy a ranch and if I died tomorrow they would have to sell That is okay So, you quit working, theie is no use earning any more money You can make enough to live well on and you don't care because they will have to sell it to pay the est'Lt( tax If you give the incentive, the people that are slacked off 01 will quit or will keep on trying to build a better estate if they feel the way most of the people that I represent do and you will get back youi money at least 10 times over There is no doubt about it fhat is what this great country is built on Mr JACOBS I don't know that I asked that but I am very happy to have that in the record Mr POTTBERG I will let someone else answer that Mr BRANNON That is the carry over basis I think it is a very inadequate substitute and barely bettei than the present system PAGENO="0659" 645 Basically, it gives you the wrong answer in that I think the useful way to look at this appreciation is that this is something that hap- pened during the lifetime of the decedent. This increased in value and it is related to him. The carry-over basis tells the heir you don't have any tax to pay if you don't sell the property. If you think it would be good to sell this property and go into some business on their own, we are going to hit you on the head. If you keep the property, we will give you a special break. Now, I see no reason why Government should be in the business of, in effect, telling the heirs that we will treat you nicely if you hold on to the property and we will hurt you if you do some sensible business arrangement and get the property in the form that will be the kind of business that you do well or whatever a sensible reinvest- ment plan is. Also, that ties into this continued lock-in problem. Basically, you are keeping the capital gain in the form that will give anybody a break if you don't sell. Mr. JACOBS. Would your answer be any different if you applied the same proposal to those properties which the Congress found to be in jeopardy for continuation of production of income or perhaps even as a so~ial judgment that the Congress found to be in the best inter- est of the country generally-the wheat farming operations and others as well? If it were applied only to that kind of operation, would your answer be any different and would it alter your opinion? Mr. BRANNON. No, because I think you ought to get out of the habit of saying that if there. is some advantage for the country you ought to discharge this by giving some tax benefit to a person who would otherwise have a large tax benefit. If you want some estimates for maintaining open spaces, go out and buy them and don't put it in the situation that if you are relatively wealthy w~ will make holding this more attractive, if you are not relatively wealthy we pay no atten- tion to it. So I would say in his situation, be more forthright with it. Mr. JACOBS. Even if your answer is the Waltons, your position would be the same? Mr. BRANNON. Yes. Mr. GUYT0N. I think it would be very difficult to comply with and very difficult for the IRS to administer, and these reasons are set forth at length in our written statement. But as I understood your hypothetical statement, you were saying the Federal estate tax would be based on the tax basis, adjusted tax basis of the taxpayers and the property rather than on the fair market value. As I un~ler- stand the proposals by the others, it is that you value property at the date of death~ based on fair market value and then you have a carry- over basis in addition, so they are getting it both ways and we are certainly opposed to that. Now, on your proposal if you are going to tax the property based upon the decedent's cost basis in it rather than on fair market value, I suppose our organization would say that would be all right. Mr. JACOBS. Could I ask you, when you say "cost basis," is that what you mean by the depreciation basis for the capital gains tax? PAGENO="0660" 646 Mr. GUYTON. That is the depreciated basis. In your example if you had $100 you paid for the property and it was depreeiated down to $5 you would compute the Federal estate tax on a value of $5.00 and the heirs' basis would be $5.00. Mr. JACOBS. If the heirs sold it for $100, he would have a liability against $95 of capital gains? Mr. GUYTON. Yes, at that time and I think in that situation our organizations would say, the livestock industry would say if you went to that, that that would seem to be equitable as long as it was on both ends. But the proposals, as we understand them, that are being advanced to this committee are that you would impose an estate tax on that property at $100 at date of death but would only allow the heirs a $5 cost basis. Mr. JACOBS. I understand that and I can only speak for my own proposals to the committee and I don't know whether it will be one of my proposals or not, and that is what I am trying to find out now. For years~ I have felt or I have thought it was unfair. I am soit of like Mr Brannon My father has a pretty fair estate built up, too, and I always thought it was terribly unfair that he should have been giving income tax deductions for depreciation through the years and those are accounting losses, let us say it, this real estate is going to stand for a long time-that he should have been giving all of those and then I, on the other hand, should take a brand new market value basis, as somebody said, windfall or manna from heaven or big daddy, or however you are going to say it and if I sold it the next day I would have no capital gain. We don't have a capital gains liability for that property. Somebody paid extra taxes to make up for the depreciation that my dad has taken all of that time and I didn't do anything to earn the prop- erty. Mr. GTJYTON. Your e~tate would have paid for it. Mr. JACOBS. In the recent example, the estate tax would be $5.00, the base on $5.00 evaluation and then jf I choose not to continue the option of that property but choose to sell it for $100, the $95 then would be a capital gains for which I would be liable, according to my own income in varying degrees, for a tax, a full capital gains tax, which I might add, I believe, would have a higher impact would it not than the estate tax? That is assuming I was making anything at all. Mr. BRANNON. It depends on the level of the estate. Mr JACOBS So if the apple didn't fall too far from the tree my income would put that $95 in a position where it would be taxed more to say? Mr. GUYTON. It could very well be under our minimum tax pro- visions. Mr. BRANNON. Could I make one comment there. I misunderstood your question when I responded earlier. It was simply commenting on a carryover proposal and I did not understand you were sug- gesting to use the basis or adjusted basis as the estate tax value. I would not favor that. S Mr. JACoBS. My other question is this, and maybe you have com- mented on it and I apologize for the delay in my arrival, but what PAGENO="0661" 647 about the farmer in the deli or the farmer and his wife where maybe the main part of that operation is $1,000 in 1928 and put that up as a down payment on the land and the land paid for itself by income from the operations, but as one of the staffers suggested to me earlier this afternoon, no one was smart enough to form a partnership, a legal partnership and make such income tax returns through the years. Now there is a death of the male, and the female of course, has never made an income tax return, but she has worked like hell all of those years, and she has sheared the sheep, and churned the butter, and all of the rest. Does anyone here have a proposal to do something about that? Mr. GUYTON. Yes, Mr. Jacobs, in our oral statement we propose that consideration be given in legislation to recognize the value of the wife's contribution to the farm and ranch in those circumstances. Let me give you a little background, in my own practice that it is not uncommon to find that a farming ranch is owned jointly by husband and wife. Then the husband usually dies first and the wives have longevity beyond us guys, and they work as a team. Yet when the farmer dies, because the wife has not contributed any cash amounts to the farm or ranch, the IRS will then come in and say at that time that the whole value is includible in the husband's estate. In many cjrcumstances the wife can go and fight the Internal Revenue Service in court, and there is a tax court decision dealing with an Iowa farm where the court did recognize the wife's contribu- tion in a farm partnership situation. But the problem is that it is an added burden of costs for these estates to go and hire lawyers and accountants, and we feel that that is not a necessary cost to impose upon these farming ranch estates. Mr. BTJRLESON. Thank you very much. I have just a couple of short questions. One of them is inspired by Mr. Waggonner's question rela- tive to the method of valuing farm and ranch land for estate tax purposes. I think, Mr. Shoemaker, you made reference to that earlier. Will you comment? Mr. SHOEMAKER. Yes. We feel it is more important today to real- ize that these evaluations, due to inflation and our economy today, are considerably out of line with the productivity of a farm or ranch land. The same thing applies to some small businesses. We recommend, and have mentioned legislation, that has been in- troduced that would certainly receive our support that productivity be considered as an alternate formula in the valuation of real prof- erty for estate tax purposes. But this is the reason for it. If any one of my colleagues wish to comment further, I would be glad to have them do so. Mr. BtTRLESON. I would like to ask one further question before any comment is made. Do you have at hand a present debt situation in agriculture generally, and, if so, how does it relate to the estate tax question? Mr. POWELL. I have the figures from the USDA bulletin 389 which indicates that the real estate farm debt, as of January 1, 1976, is 145 percent of the 1965 figure or $46 billion approximately. The nonfarm debt at the same time is $29 billion or 190 percent of the 1965 debt. PAGENO="0662" 648 Now, to put that in perspective, the total debt of the farming enter- prise in this country as a percent of farm assets in 1965 was 11 per- cent. In 1975 that debt had rise to 27 percent. Now, this speaks to the point that the farming industry is ever increasingly becoming illiquid, and if estate taxes continue to in- crease in the proportion and magnitude that they are levied today on the selling price value of the real estate, this illiquid will be further increased. Mr. BTJRLESON. I think that is very impressive and I am glad to have it in the record. I have just one other question. Mr. Cunningham, with regard to the statistic you gave earlier, the one that I hadn't heard, did I understand you to say that one young man going into agriculture, would relate to 107 older farmers and ranchers now in the business? Mr. CUNNINGHAM. This is people dependent on farming for a liv- ing. There is one man between the age 20 to 25 to every 25 that is over 60. Mr. BURLESON. Is that the national average? Mr. CUNNINGHAM. I don't know this because my office got thçre figures for me and I don't know if they got them from State or national, but I certainly will check it out. Mr. BURLESON. Well, the national average of the farmer and rancher today is some place just over 54 percent, I would think. Fortunately, that had dropped some in the last few years. For some years it was 56 per cent, so it has dropped a little. But I think that might bear out the statistic that you just gave. Mr. CUNNINGHAM. I think so. They are now separating the full time from the part time so we will know exactly who is farming and ranching. As far as I know now the migration to the cities stopped in 1972 when we started making a pretty good profit. It started back in the last part of 1973, and the year of 1974 1 percent went to the city and the year 1975 another 1 percent went. The way it is going now, it will be down to a little less than 4 per- cent producing the food now. I think it will be down to 3 percent in another 3 years the way it is going. Mr. BURLESON. What is going to happen if a young man starts farming or ranching a unit, and he has to have $150,000 to start un- less he gets it from his father? Then if he does that, he is going to buy CD's and savings and loans where the weather or disease or hard work or whatever it is isn't going to affect it. Who is going to pio- duce the food and fiber in just a very few years? Mr. CUNNINGHAM. We had to make that decision just shortly. I have a son, as you know, who works for Senator Bentsen and lie wanted to ranch. So we tried it for two years. We leased the land and bought the cattle and, of course, we bought high-priced cattle and the market fell and in two years we were able to lose $600,000. But the way it is going now, if you own your land and operate on your own capital you can manage to lose about $80 per cow that you own. Now in farming it is a little better than that. I have a son-in-law who grows grain and he is operating on leased land and some owned land and he inherited this land and he paid PAGENO="0663" 6:49 the inheritance tax and it took $600,000 to put him in operation the first year. it takes about $160,000 to buy the equipment for 300 acres. Mr. BURLESON. That is just the point. Unless you are already in the business there is not going to be anyone to start in the business. Mr. CUNNINGHAM. No, sir, if it keeps going the way it is going now, the United States won't have to worry about food being the strongest weapon we have. You have heard that. In five years we won't have enough production to feed this country because everybody wants to come down on it and there are not enough people who want to sweat and work hard and you are discouraging the ones who do want to. There is no way we can keep them there unless someone gives them a break. Mr. BURLESON. Thank you very much. It has been most informative and a very good discussion. Mr. BRANNON. Could I just make a quick comment on this topic you brought up of farm income and farm evaluation. I think you ought to remember that this is a Bicentennial year. It is the 200th Anniversary of the publication of Adam Smith's Wealth of Nations which was a classic statement of a market economy. Now there is a great deal of wisdom in that. It does suggest that when the market attaches a very low income to cattle ranching, may be it is telling you something, that the society doesn't want to buy this much meat and if the production falls off you would expect in a market economy that the price would go up and that consequently as the market economy works this supply is adjusted to demand and things take care of themselves very often. Mr. BURLESON. A Bicentennial year would be a good time to give confidence back to people that they are working for something and that they are able to pass on to their proteges a bit of their labor. This would be a good time to do it. Are there other comments or questions? Mr. JONES. We have no unwillingness to live with the rigors of the market. It is when the finger of Government comes in and upsets that market and upsets the pattern of the free market that we then come in to testify against such things as income taxes or estate taxes and so forth. It is a serious drain on the technology of agriculture when we lose the farm and ranch youth and do not give them an incentive to stay on the land. We can make a great contribution to this by giving them some in- centive through changes in the estate tax area and, therefore, retain that technology. Mr. BRANNON. We hope the committee will not take the situation of my gentleman to the left that if you think the ranchland should be retained you should buy it. We don't want you to go that route. [The following letter was subsequently received for the record:] MARCH 24, 1976. Hon. ANDY JACoBs, Jr., House of Representatives, Longworth House Office Building, Washington, D.C. DEAR Mn. JACOBS: During my testimony before the Ways and Means Com- mittee on Estate Taxation on March 16 I made a misstatement in response to a question of yours on page 404. PAGENO="0664" 650 Your question referred to the possibility that the national interest might be served by granting estate tax relief for property left in particular uses. I replied that if we wanted open spaces we should buy them This is not quite what I wanted to say, but I would prefer not to correct the record because another witness later tookme to task for my misstatement (page 415). In the proposal that you were discussing I was making the following point When we encourage particular land uses by way of estate tax relief we are committing the government to a payment for desirable land use but the size of the payment becomes larger the richer is the beneficiary You would give no payment for a property that involved no estate tax liability (This could be a large property but could have no estate tax liability due to debt or marital deduction) You would give a large benefit if the decedent was so rich as to have a large taxable estate My point is that whatever revenue you propose to give away in this fashion could be better spent by making payments for keeping land in desirable uses under a plan in which the payments were not larger the richer the landowner I am not familiar with all the legal possibilities but certainly you could do things like making loans to anyone who will farm the land. Sincerely, GERALD M. BRANNON. Mr. BTJRLESON. You have been very helpful. The committee will adjourn until 9:30 in the morning. [Whereupon, at 4:25 p.m., the committee adjourned, to reconvene at 1~ 30 a m , Wednesday, March 17, 1976] PAGENO="0665" FEDERAL ESTATE AND GIFT TAXES WEDNESDAY, MARCH 17, 1976 HOUSE OP REPRESENTATIVES, COMMITTEE ON WAYS AND MEANS, Washington, D.C. The committee met at 9:40 a.m., pursuant to notice, in the committee hearing room, Longworth House Office Building, Hon. Al iJilman (chairman of the committee) presiding. The CHAIRMAN. The committee will be in order, please. We have before us our colleague from North Dakota, Mark An- drews. We are very happy to have you before the committee. Without objection, your statement will appear in the record. You may proceed. STATEMENT OP HON. MARK ANDREWS, A REPRESENTATIVE IN CONGRESS PROM THE STATE OP NORTH DAKOTA Mr. ANDREWS. I appreciate very much, Mr. Chairman and members of the committee, your giving me this time. Certainly I appreciate this opportunity to make a brief statement on the need to rewrite our estate tax law. As the law now stands, it seriously endangers the future of our whole system of farm family agriculture-the most efficient and most pro- ductive type of agriculture in the world. The $60~000 exemption is completely unrealistic-and has been for years-in a period of soaring farmland prices. In my State of North Dakota, for example, farmland prices have more than doubled, overall, since 1967-and in many areas, land prices have more than tripled. In the year 1974, average farm real estate in my State jumped 39 percent in 1 year. As one farmer told me recently, "Mark, I can't afford to die under these estate taxes-my death would absolutely wreck my farm unit for my two sons and widow." Unless a farmer has figured out some way to avoid owning anything by the time he dies, anywhere from 25 to 40 percent of the farm or ranch may have to be sold to pay for the Federal and State death taxes on the estate, plus administration costs. All you have to do is check the probate record in the county courthouses in my `State to believe me. Estate taxes under the existing law can be brutal if you own farm- land worth $250,000 on up-which is not unusual in North Dakota. Actually, Mr. Chairman, I think we have to recognize when we are dealing with the Members of Congress and the press and the general public that this is not an appeal to take care of a few so-called fat cat (651) PAGENO="0666" 652 farmers Take an average farm in northern Iowa, for instance, of 400 acres A man and wife married 30 years ago bought the farm from their father or father in law or whoever it might be It was worth $100 an acre, $40,000 They probably had a $20,000 mortgage and $20,000 worth of equity Now their son or their daughter is ready to take over 30 years later They haven't added to the farmland. It is still 400 acres but today it is worth $2,500 an acre in northern Iowa or southern Minnesota land That is $1 million, Mr. Chairman. Our farmers out there are land- rich and cash-poor. I would like to show the committee and other people this local farm magazine, The Farmer This happens to be a re gional publication, The Farmer. In here is an article on cost-price pro- jections It says, "Soybean outlook dismal, corn little better," and quotes a University of Minnesota farm management expert who says that soybean growers in most areas have little hope of breaking even this year and a corn grower isn't much better off So you can see the profit in farming just isn't there My point is that this is not a bill just for the farmers or farm fam ihes This is a bill, Mr Chairman and members of the committee, to take care of our consumers who need an adequate supply of food and of our NatiOn which needs food exports to pay for the increasing cost of oil imports. It will be suggested, I know, that by raising the estate tax exemp tion we are just creating another tax loophole I don't go along with that argument All we are asking is comparability with other busi nesses, and if you take a look at the $60,000 to $200,000 figure, that is part of the parcel Another part is valuing farmland on what it re turns on investment USDA figures show that farmland returns 2 percent on invest ment or less, business property in town returns 10 percent or more. We are not asking for anything special. We are just asking for compara- bility and to a farm wife who has put in many long hours beside her husband building up a farm estate when he dies suddently and trag ically it becomes even more tragic when IRS comes in and says "prove that you contributed in cash" She has by sweat and a work equity put into that farm as much as you can over 30 years of a lifetime and IRS should recognize this Mr Chairman, I appreciate the time you have given me I sincererly hope that this committee, in its wise judgment, will see fit to remedy this problem that affects our farm families and our Nation and, as a matter of fact, our entire economic future [The prepared statement follows ] STATEMENT OF HONORABLE MARK ANDREWS A REPRESENTATIVE IN CONGRESS FROM THE STATE OF NORTH DAKOTA Mr Chairman and Members of the Committee I appreciate this opportunity to make a brief statement on the need to rewrite our estate tax law As the law now stands it seriously endangers the future of our whole system of farm family agriculture-the most efficient and most productive type of agri culture in the world The $60 000 exemption is completely unrealistic-and has been for years-in a period of soaring farmland prices. In my state of North Dakota, for example farmland prices have more than doubled, overall, since 1967-and in many areas, land prices have more than PAGENO="0667" 653 tripled. In the year 1974, average farm real estate in my state jumped 39 per- cent in one year. As one farmer told me recently, "Mark, I can't afford to die under these estate taxes-my death would absolutely wreck my farm unit for my two sons and widow." Unless a farmer has figured out some way to avoid owning anything by the time he dies, anywhere from 25 to 40 percent of the farm or ranch may have to be sold to pay for the Federal and State death taxes on the estate, plus admin- istration costs. All you have to do is check the probate record in the county court- houses,jn my state, to believe me. Estate taxes under the existing law can be brutal if you own farmland worth $250,000 on up-which is not unusual in North Dakota. For example, if your taxable estate is $200,000, Federal and State estate taxes and administration costs can run over $50,000 and when the widow dies the tax bill could run as high as an additional $90,000. Most farmers these days, do not have huge cash savings for quick payments of `amounts running into five or six digits. The average farmer today is land-rich and cash-poor and under the present estate tax formula, the family has no al- ternative but to sell `off a substantial part of the farm to pay for the taxes. In time, this concept of estate taxes will completely wreck our family fram type of agriculture-~wbicb would be a national tragedy. It will be suggested, I know, that by raising the estate tax exemption we are just creating another tax loophole. This is a specious argument. All we are asking is comparability with other businesses. I would like to point out that, using USDA's own figures, investment in framland returns about two percent, whereas investment in business property normally returns up to ten percent and more. An inheritance tax formula, for farmers, then should be based on income-producing ability, rather than on speculative land prices. This would put family farms on a basis of comparability with family city businesses. It is for this reason, Mr. Chairman, that I, and a number of my colleagues in this House, have introduced, over the past three years, a variety of bills to cor- rect and reform the estate tax laws. I think a minimum and realistic level of exemption should be raised from $60,000 to $200,000 and I hope this committee will give serious and favorable consideration to this and other long overdue changes. Thank you. The CHAIRMAN. Thank you, Mr. Andrews. Mr. Schneebeli. Mr. SOHNEEBELI. Thank you, Mr. Chairman. I welcome the leadoff witnes,s for our session today. Mr. Chairman, I think this legislation has generated more interest on the part of the Members of Congress than any bill that I have seen in the 15 years I have heel on this committee. There are many Members of Congress scheduled to appear before the committee ~n this matter, and not only those from west of the Mississippi. I see two of the witnesses here today are from the neighboring State of Maryland. I am very pleased that the chairman has scheduled hearings on this very vital subject and I hope we get legislation early in this congres- sional year. Thank you very much for your observations. Mr. ANDREWS. I appreciate your comments, Herman. I am not only here representing farm families but, as you know, I am the ranking member of the subcommittee that funds the Department of Agricul- ture and all the agricultural programs. In that position we hear day after day after day the economic problem farm families find them- selves in and this translates into problem 2 or 3 or 4 years hence for our Nation. You can't bring a kid off the streets of Chicago and make a farmer out of him, and if you don't continue the farm family system that has PAGENO="0668" tiM kept our Nation adequately fed and given us the opportunity to ex- port, this country is going to be in a real tough way That is our secret of success. Collectives can't raise crops. We learned that in Russia. The big Latin hacienda doesn't work. Farm families do. Unless we pay attention to them, as a nation we are in trouble. Mr. SCHNEEBELI. The beneficial role the farmer has played in our balance of trade is quite obvious. Our exports of farm and agricul- tural products have increased from $6 billion to $23 billion in 3 years. This demonstrates the need we have for the relatively small farmer. Mr ANDREWS That $23 billion of wheat exports just paid for the minimal cost the Arabs charged for our imported oil. Mr. SCHNEEBELI. I keep reminding the committee that this applies not only for the farmer but for the small businessman, too. Thank you, Mr. Chairman. The CHAIRMAN. Mr. Conable. Mr. CONABLE. I would like to welcome our friend to the committee and also to ask him if what we do in this area probably won't have more to do with the future structure of the American farm community than will any Government farm program Mr ANDREWS There is no doubt about it, Mr Conable In m~ own township in the last 4 years we have seen two fourth generation farmers, unable to continue on their farms because of these tax prob- lems I think that is certainly tough for them because they are young men 28 and 30 years old who would like to farm but it is much tougher for the consumer in the big city. Mr. CONABLE. I would also like to ask my friend who knows so much about farming if it is not also true that collection of capital gains tax at death would be every hit as damaging as the low exemption, the un- adjusted exemption despite the inflation of recent years. Mr. ANDREWS. They are all part of the picture. What we need is an economic unit on the farm and I used as my example $1 million which is a 400 acre farm in northern Iowa or southern Minnesota That is not a big operation In fact, a family farm in that area can well be in the 800 to 1,000 acre figure. We are not talking corporation farms but we are talking family farms. Mr. CONABLE. There has been, as you point out, tremendous ap- preciation in the value of farm assets along with the increasing costs on farms Therefore, collecting capital gains at death would itself be a damaging alternative That is something I think this committee must keep in mind We are not going to help the farmer by greatly increas ing the exemption and then taking everything back through the col- lection of a capital gains tax at death. That is one of the alternatives facing the committee I personally think it would be a mistake for the farm community, were we to do that Mr. ANDREWS The big problem, of course, is that the value of farm real estate no longer is tied to its productiveness or its earning power as farmland. It has been run up because of speculation from people in the cities who come out and drive that price up In no other business today do we find the capita] investment return is oniy about 11/2 to 2 percent PAGENO="0669" 655 Mr. CONABLE. rfIlanl you, Mr. Chairman. The CHAIRMAN. Mr. Duncan. Mr. DUNCAN. I think you just. asked the question 1 was going to ask. I want to compliment. you on taking the. lead in this very important problem. I sympatluze with you and generally SuppOrt your con- tention. I was going to ask if a soybean farmer doesn't make a living in Iowa or Minnesota, why is the land so valuable, $2,500 an acre? Mr. ANDREWS. Because of people in the cities coining out as a hedge against inflation and they are running up the value of this land far iiiore than its value today. They are betting that 10 years from now if the Congress or the administration or whoever has been making the mistakes around here-and I am not casting the blame on any of us because I think there is enough of it to go around-but if we continue the way we have in the last couple of decades, 10 years from now the person who pays too niuch for farmland now is going to come out ahead if he can afford to wait-but the working farmer can't enjoy that. luxury-he doesn't have the cash. That doesn't do the farmer any good because he can't continue to pay his operating cost.s as well as death taxes. Farmland has llaI)pened to be. used in the last several years as the hedge against the inflation that surrounds us, but the farmer has no control over this, rather is vic- timized by it.. rilliat is why he. particularly needs help today. Mr. DUNCAN. Thank you. Thank you, Mr. Chairman. The CHAiRMAN. Mr. l3urleson. Mr. BURLESON. I join in welcoming our colleague from North Dakota to test.ify before this committee. A number of us are proposing that the estate tax exemption be increased from $60,000 to $200,000, arrived at by arithmetical weight related to its value and inflation and so forth. Do you support this change? Mr. ANDREWS. I totally support that and I am extremely proud, Mr. Burleson, to be a cosponsor of the bill that you originally introduced and t.hat. you are the lead sponsor on, known as the Burleson bill. I think this goes a long way. I wanted to make clear that two other things needed to be done; one, to make sure that the farmland is valued at its earning power and, two, that time farm wife who has contributed so much and is listed on the (Iced 50-50 with her husband be recognized as owning 50-50 and not have some IRS agent come at her 35 years after she. hRs been on that farm and tell her on the death of her husband that she hasn't contributed anything unless she can prove she paidi the cash. Mr. BURLESON. I hope we can accomplish that. Thank you. The CHAIRMAN. Are there other questions? If not, thank you very much, Mr. Andrews. Mr. ANDREWS. Thank you. The CHAIRMAN. Next is our colleague, Robert McEwen, the distin. giushecl Member from New York. We. are happy to have you, Mr. McEwen. Without objection, your statement will appear in the record in full. You may proceed, sir. PAGENO="0670" 656 STATEMENT OP HON. ROBERT C. McEWEN, A REPRESENTATIVE IN CONGRESS PROM THE STATE OP NEW YORK Mr. MOEWEN. Thank you. Mr. Chairman and members of the committee, if I am correctly informed, the bill that I have iut.rodiiced that is before your commit- tee is one of approximately 100 on this subject. I believe, that is some indication, Mr. Chairman, of the interest and concern for this problem, and Properly so. I noted that in one of our great. national publications they referred to time fact that this exempt.iou, which was set. at. t.he figure it. is now, in i942~ would now be $210,000 if the. inflation factor is applied. I woi.ild like to address myself specifically t.o time subject that omu' colleague, the gentleman immediately p receding me in time witness chair, Mr. Andrews, spoke of. I-Ic spoke with knowledge of agriculture in the great Midwest. I would like to call t.o the attention of t.h~s com- mittee a few figures that I think tell the story on Northeast. agricul- ture as I see it in my own district.. What has happened is that. our farm units have grown larger. In the seven counties of northern New York that. are in my congressional (us- t.ric.t, the Census Bureau informs me that a little over two decades ago, in 1954, there were. over 13,000 dairy farms. In 19T4 there were 3,815. Now, if you will keel) in mind that during that period of time production of milk stayed at the same or a higher level, you realize that what. ha.s happened is that. those fai'nms have grown larger. I can remeniber as a youngster when we had the 12 awl 15 cow dairy farm and people made a living off of that farm. Not. any more, gent.le- men. That day has long since passed. To be a viable economic unit the family farm in dairying, as in other endeavors, has had to grow in size.. That has meant a growth in three areas: more land, more cattle and more machinery. The result is now that when it. comes to passing that farmn on t.o the next. generation time cash snuply is riot, there t.o pay time State and Federal est.at.e and inheritance taxes. I think there is a concem'n, as my friend, time gentleman from. North Dakota, mentioned, that goes beyond just. equity and fairness to these families. There is a larger national concern. 1 would like. to speak of just two aspects. One, we can relate t.o the consumer, the other to con- servation. Let me take the latter first.. This Congress has enacted many progran and appropriated a great. deal of money from our Public Treasury for conservation programs. I suggest that. we not forget. that the earliest mmcl best and continuing conservation practices that we have seen in many parts of this country have been on time family farm. Time family that is on the farm at any given time is the inheritor of that. farm from a preceding genei.'at.ion and plans to pass it. on to succeeding generations awl has tried to main- taiii the quality of that soil, that. land that. i's basic to any agriculture. Then there is time consumer aspect.. 1 realize that. your committee, Mr. Oha.irman, is and propei.'ly should be. concerned about. anything that means a loss of revenue to oui.' Federal Treasury. However, I think we are facing a possibility of another loss if `there is not. some action taken in this area and one that would `seriously affect. all of us a.s consumers. PAGENO="0671" 657 You know, we have heard a great deal lately about consumerism. I would suggest that we better keep in mind that the very basic first thing that every consumer has to have is a producer, hopefully a good producer, an efficient producer, costwise an'd qualitywise, but some sort of producer. If there is nothing produced there will not be anything to consume. I have `seen farms in my own area, Mr. `Chairman, where young people simply cannot raise the capital to start farming. The only way we are going to keep farms is by enabling them to pass them on from one generation to the next. So, I `say, from the standpoint of good conservation, in `the continu- ance of t'he family farm where they look to passing it on there is an incentive to do that because t'hey know future generations are going to have it. From the standpoint of the consumer, we `have to assure the food and fiber that America needs, and, yes hopefully to contiunue producing an abundance so that we can export which helps so much in our balance of trade and balance of payments. So as your committee looks at this problem, I do hope that it is looked upon as not just an equitable relief to an important j?art of America, which it is, but beyond that an assurance that America in t'he future will'have the food and fiber it needs. Mr. Chairman, I thank you for the opportunity of appearing before you and your committee. The CHAIRMAN. Thank you very much. Mr. Schneebeli. Mr. SCHNEEBELI. Thank you, Mr. Chairman. As a colleague from a neighboring State, I welcome the regional focus that Congressman McEwen has given `us. I was reminded of the importance of farming in our two States last week when I was informed that Pennsylvania has more farmers than any other State in the Union. I am sure that you have a lot of farmers up your way. People seem `to forget t'hat we do have farmers in the East and that estate taxes pose a very important problem for the people of our area. You have represented their interests in very fine fashion an'd we thank you very much for your very fine `testimony. Mr. MCEWEN. ,Thank you. The CHAIRMAN. Mr. Conable. Mr. `CONABLE. I would like to thank my friend for coming and presenting essentially, the view of the dairy farmer in `his area. The same is true in my area. It is your view that the dairy farmer is in a liquid position? We have a serious problem of ill-liquidity, `obviously, in the Farm Belt, but is the dairy farmer in any more liquid a position than the soybean or grain farmer? Mr. MCEWEN. I would say to the gentleman not a bit better off because they have been caught, as the gentleman knows, in a serious cost-price squeeze in recent years and at the same time have been obliged to expand wherever possible their operation, and so have gone into larger machinery, more acres of land and more cattle. `Then I would suggest that when it comes to paying the tax, when you must liquidate to pay the tax, it `has to be a balanced liquidation. You can't sell all the land. You can't sell the cattle because then there wouldn't be anything to produce off the land. PAGENO="0672" 658 Mr. CONABLE. I would like to suggest that the results can be more irreversible in the dairy area if you have to liquidate the farm for estate tax reasons than in the grain and soybean producing parts of the country because once you disperse a herd, once you fail to keep up with the capital needs of a milking parlor and so forth, you are not going to reconstitute the unit just because the price of milk goes up a cent or more. `Mr. MCEwEN. The gentleman is absolutely correct in that observa- tion Once the herd is dispersed, it is dispersed I go back, if I may, to the figures of 13,000 dairy farms in my district in 1954 declining to less than4,000 in 1974. In 20 years two thirds of those dairy farms disappeared It didn't mean that all that land was necessarily lost to production In many cases it went into an adjoining farm which became larger and that, of course, exacerbates the problem of how to meet the inheri tance tax because they have had to expand to be economically viable Mr CONABLE I thank the gentleman for bringing up the problems of our area. Mr. DUNCAN. Mr. Chairman. `The CHAIRMAN. Mr. Duncan. Mr. DUNCAN. I want to welcome our colleague to the committee and also say that there is no one who has been a bettei advocate of this cause than you have I think you were here when Congressman Andrews mentioned the fact that in Iowa `md Minnesota the land had gone up to $2,500 an acre How does that compare with the dairyland in your area Mr MCEWEN Mr Duncan, land values have not increased as greatly, at least in my area of the Northeast, as they have in the Midwest I listened with interest to the figures that Mr Andrews gave, and I see Mr Schneebeli nodding his head, that generally I think in the North east our land values have not increased as greatly Mr DUNCAN What is the average investment in `m dairy farm ~ Mr MCEWEN Here, again, we are getting into whether you are getting into just the land but I assume you are talking about land and buildings I would say that from recent sales that I have heard about to get land and buildings sufficient to operate a dairy of sufficient size to have a viable operation it now costs at least a quarter of a million dollars Mr DUNCAN Do you have a lot of people going out of the dairy business and finding better use for their land ~ Mr MCEWEN We have had some that have gone out of the business May I say that I speak of dairying because it is the largest segment of agriculture in my district We also have the cropland where they raise lettuce and onions and also the McIntosh apple country of the Champlain Valley All of these operations have expanded as they have had bigger, more efficient machinery They have expanded their operations and they all face the same basic problem but I think our dairyman is in the most critical situation because he has to have a substantial operation to be economically successful. Mr. DUNcAN. Thank you very much for your fine contribution. The CHAIRMAN. Mr. Burleson. Mr BURLESON I join in welcoming our colleague from New York before the committee I thought at first that our colleague from New PAGENO="0673" 659 York was making a pun talking about dairying being hit. However, his statement applies across the board to all farm and ranch operations, as I think you would agree. You have made the very pertinent point that the oniy real conti- nuity we will have in this Nation in agriculture, all agriculture, is in passing the farm on to the next generation. That is the only way. The average age of a farmer and rancher today, as I understand it, is about 54 years of age which is a little younger than it was a few years ago. But looking on down the years, who will produce the food and fiber if we don't keep the younger people operating in agriculture? If a young man has $200,000 or $250,000 he is more likely to buy bank CD's or savings and loan certificates where he doesn't have to depend on the elements and doesn't have to get up at 5 o'clock in the morning to milk, is that correct? Mr. MOEwEN. I agree completely with the gentleman from Texas. This is the large interest that as a Nation we should take in this. How do we continue? As you suggest, it is only by passing it on that we keep people in this endeavor. Mr. BUELESON. I thank the gentleman for his contribution here. The CHAIRNtAN. Are there other questions? If not, thank you very much. Your testimony has been very helpful. Mr. McE WEN. Thank you. The CHAIEMAN. Next we have our colleague from Illinois, Mr. Tom Raileback. Welcome to the committee, Tom. Without objection your full statement will appear in the record. We will be happy to hear you. STATEMENT OP HON. THOMAS RAILSBACK, A REPRESENTATIVE IN CONGRESS FROM TEE STATE OF ILLINOIS Mr. RAIns1~wK. Thank you, Mr. Chairman. I apologize for this "mellifluous" voice, as Barber Conable called it. Mr. Chairman and members of the committee, I guess that there is no legislation that I feel more strongly about this year than this paiticular legislation I say that maybe for some reasons that are a little bit different than those advanced by earlier proponents, although I certainly support the thrust of their remarks. Here is the way I feel about it. There is a national policy in this country of encouraging full agricultural production. That is an ex- pressed, announced American policy. There are several reasons for it. First, we have many, many hungry people in this country, people who are undernourished or malnourished. Second, we have at last recog- nized that there are many, many people throughout the world ~rho are hungry. America. with its fertile soil and abundant natural resources has the means to help those countries feed their hungry people. If I could refer you to pare 2, the second paragraph, I think th.at is really where I would like to begin. I think that the American farmer, at great risk, has met the challenge to fully produce. That production has resulted in helping us hold down consumer prices. In addition, it has helped us to meet the challenge of producing for the hungry people of the world, and the hungry people of ~ur country. What has that policy meant from an ecOflomic standpoint? About 3 or 4 years ago this country was in a great deficit as far as balance of trade. This last fiscal year we were able to export $22 billion iii farm 68-872-76-43 PAGENO="0674" 660 exports. That means we are going to have over a $10 billion favorable balance of trade. What has the present estate tax structure meant to a typical family farm? Let me just recite one instance that I had in my own congiession- al district that really prompted me, very early last year, to introduce a bill raising the exemption from $60,000 to $1852000. I had a young farmer and his wife come to see me during district office hours. The woman, whose father was a farmer who had died, was close to weeping for this reason: Her lawyer had advised them that on a relatively average-size farm they were going to have to pay over $200,000 in costs. This was due to the cost of their State inheritance tax and the Federal estate tax and I am sorry to say, attorney's fees, because I am an attorney. As to what the practical effect of that is for those of you who are not familiar with the general Midwest farming operation, here is the situation: Farmers have a net return on investment of about 4 percent or 5 percent, and I think, from an economic standpoint, that is the single most important figure to remember-they have a net return of 4 percent or 5 percent. The average farm income is something between $9,000 and $10,000. According to the U.S. Department of Agriculture, 70 to 90 percent of typical farm assets are in land, buildings, and machinery. I happen to also represent the farm implement manufacturing centor of the world. Deere & Co., J. I. Case, and International Harvester are all located in the 19th District. What has happened is that the costs of equipment have literally skyrocketed. So the average midwestern farmer has very little cash reserve or liquidity. We have a national policy, which is a good one, of all-out production to stabilize food prices and to stabilize farm prices. I have seen in my district time after time forced sales of farms. Those forced sales are not always to other farmers; sometimes they are to developers or real estate speculators. So what I am saying is that I think that we are frus- trating this national purpose of encouraging full production and sometimes I really wonder why farmers and their heirs and successors want to continue farming but the truth of the matter is that many of them do. I hope that this committee will do `something to help preserve that family farm. Mr. Chairman, may I have permission to have the text of my written statement inserted in the record? The CHAIRMAN. Without objection your full statement will appear in the record. We feel for you in your voice situation and hope that it improves rapidly. It is somewhat of a handicap for a member of our profession. Mr. RAILSBACK. I think maybe I am better off without it. Mr. CONABLE. Mr. Chairman, I thought it was quite mellifluous. The CHAIRMAN. The gentleman is a member of the Judiciary Com- mittee and appreciates some of the legal problems involved. Mr. Burleson. Mr. BURLESON. I have no questions. The CHAIRMAN. Are there any questions ~ Thank you very much, Tom. We appreciate your testimony very much. Mr. RAILSBAOK. Thank you. [The prepared statement follows:] PAGENO="0675" 661 STATEMENT ~F Hox. ToM EAILSI3ACIr, A REP~ESENTAT1&R TN' CONGRESS FiwM THE S~rATs OF' 1LL]~OlS RAISING TI~E ESTATE TAX EXEMPTIO~ Mr. Chairman, and Members of the Committee. I am here today to urge you to amend the Internal Revenue Code of 1954 to raise thO e~tate tax exemption from $60,000 to $185,000. Between 1949 and 1969 the number of farms decreased by over 2 million. A significant factor it is believed is the high cost of the federal estate tax. On February 6, 1975, I introduced H.R, 5612, which would raise that exemption to $185,000. This figure was based on the Consumer rrl~e Index of November 1974. However, we all know that land costs have continued 1~o escalate. There- fore, I would be willing to go along with some of my colleagues who would set the limit at $200,000. Under existing law the first $60,000 of an estate is exempt from estate tax. While the exemption has remained unchanged for the past 34 years, prices have increased 224%. Inflation and economicgrowth have rendE~red the estate tax structure obsolete. This leglsl~tlon Is truly needed, especially by farmers and small businesses, and indeed anyone who would leave a family to carry on. In the last decade farm value has soared due to inflation and land costs. This growth in values has resulted in a corresponding escalation in the farm family's degree of estate tax liability. A situation is then created where the cost of the estate taxes are often as much as the original purchase price of the farm. [f it is to he kept as a farming unit, capital must be borrowed to maintain the farm as an efficient business. I haTe heard from hundreds of families in the 19th District of Illinois crying out for change in the tax structure. Farm Journal and other farm industry related publications have recently taken up the issue. Il~ is well known in the heartland of America that upon the death of the farm's owner, heirs are often forced to sell their land and lose their livelihood b~cause of the "death tax." Farming by its very nature precludes for the average farm' `family, liquidity. According to the U.S. Department of Agriculture ~ev~ty to ninety percent of typical farm assets are in land, buildings, and m~~hin~ry. Only on rare occasion does an operation on the scale of the family farili have the cash reserves to pay the estate tax due. There is general recognition that there are many, many people in this world who are hungry. There Is evidence that there are many Americans who are undernourished. It is for that reason, and perhaps that reason alone, that there is a national policy to encourage all-out agriculture ,pr~duetion. American farm- ers have met that challenge despite the great risk Involved . . the Hsks which have always been a part of farming . . `~ not in the least fiuctua~lng prices. When the inevitable result is a forced sale of a farm, or part of a farm, in order to raise cash to pay an enormous estate tax, our natioial policy of encouraging all out production is often times frustrated. This is true despite the fact that it is the desire of the heirs, or successors, to continue farming. Instead the land is sold to developers or other investors. Recently a family in my District had to' sell two farn~s that had been in the family since the prairie soil wi~s broken. Obviously, it is becoming Increasingly difficult for the oWner to will land. to spouses or children with enough financial reserves to maintain a farm's or the business' operation. This is a subject not only of great coucern to me, but to many people in my District. One such person is Lee Lohman of Geneseo, Illinoi~. Mr. Lobman. has been an estate planner, a farm owner, active In the Quad Cities area of Illinois and Iowa since 1956. He has been on the board of a banl~, the advisory board of a college, and a life insurance company. Mr. Chairmau and Members of the Committee, in addition to my statement, I am submitting testimony given to me by Mr. Lobman for your `consideration. I' ask that it be included in the hearing record. As Mr. Lohman has stated, "the $60,000 exemption puts the farmer In the seemingly unusual position of having to purchase the farm for Its original purchase price a second time if It is to be kept as a farming unit or viable business." If it was socially and economically desirable that a fairly modest family farm or business, or simply a home and its furnishings couh~ pass from one generation to another In the early 1940's, when Congress last acted on the estate tax laws, it should be equally desirable in 1976. ` ` PAGENO="0676" 662 Let, us now take 4t step in the directIon of allowing a family's heritage to pass from one generation to the next. Mr~ Chairman, I again thank you and your col- leagues for letting me testify today, and I would hope that what I have said will be helpful In your consideration of pending corrective legislation. The CHAIRMAN. Our next witness is from our neighboring State of Maryland, the Honorable Goodloe Byron. Welcome to the committee, Mr. Byron. Without objection your full statement will appear in the record and you may proceed, sir. STATEMENT OP RON. GOODLOL B. BYRON, A REPRESENTATIVE IN CONGRESS PROM THE STATE OP MARYLAND Mr. BYRON. Mr. Chairman and ~nembers of the committee, it is a pleasure to be here to speak on behalf of H.R. 3832 and related legis- lation. I know the gentleman from Texas has taken the lead before your committee and in the Congress with regard to estate taxation, SO that I will speak to the narrow field that is limited with regard to H.R. 3832, and that is agricultural land estate taxation. I am sure that the committee knows that there is broad support for legislation of this kind not only here in Congress but in the United States. I would like to address myself just briefly to some of the questions of disappearing land and open space. We have all followed some of the problems around the country, so that I would speak just briefly to a few problems that any of us can see as we leave here, the Nation's Capital, to return to our homes on any given evening, and those are problems in the immediate surrounding area of Washington, some of which area I happen to represent, and these problems can be seen up and down the eastern an~ western seaboards, particularly close to the metropolitan areas. I think the'situation `in Maryland is instructive with regard to agri- cultural land and why this bill is so important. According to the 1945 census of agriculture the total area in Maryland farms stood at more than 4.2 million acres, or 67 percent of the State's land `area. By 1969 this farffi acreage had decreased to 2.8 million acres, or 44 percent of the total land area. The 1974 report b~ the Maryland Committee on the Preservation of Agricultural Land estimated that:the investment per farm in the 11,590 commercial farms in Maryland included $131;378-and this is an aver- `age figure-in real estate, $12,914 in machinery and equipment and $8,717 in poultry and livestock, for a total of $153,009 per `farm, cx- cluding inventories of feed and supplies. By 1986 total investment per farm will reach `an estimated $438,000. `I'he impact of inflation and population pressures on land is obvious `from these figures. The real estate component of farm values is rising, as has already been mentioned earlier today by our distinguished colleagues from North Dakota and New York. Incidentally; `i~i 1969 about 87 percent of the commercial farms in `Maryland were operated as individual or family organizations. Only 11.5 percent were operated as corporations. And I think that is in- structive for `all of us because I don't think Maryland in that regard is any different from any of our ~astern seaboard states. I would like to a~k that the committee, in considering legislation of this kind, consider the fact that in H.R. 3832 there is a recapture provision for the estate tax. There is also a lien provision which would PAGENO="0677" 663 secure the appropriate recapture of the estate ta~ which would be postponed, in effect, but would not entirely b~ escaped by the farm family. I would like also, if I could, just to point briefly to the fact that we arc not talking just about farming here In this area and, as I pointed out eailier, when you drive from here out into the Maryland countryside, you will see that land has conservation value and that whatever a family does in conserving and pruteMting the~ land not only protects the ±arm family but also protects us who work and who live here in the city This is true of the watershed This is true of the need for open space so that the city dweller has an opportunity to make appropriate comparisons. I would like to close, Mr. Chairman; by just referring briefly to what I consider to be an astounding example of this. I have known this certain gentleman for several years and I introduced the gentl&- man several years ago to Chairman Mills. We have in Maryland a State senator who is in the Maryland Legislature by the name of James Clark. He lives on a family farm right in the middle of Coltimbia, Md. Maybe some of you are familiar with the new town of Columbia. Senator Clark's family has farmed that farm ~continttously~ for over 200 years Senator Clark's son is farming that farm today Were Sena tor Clark to die and pass on that farm to his son, r would ask you- and I am sure it has entered his mind many, many tines or he wouldn't have come down here-where would he get the money to be able to pay the exorbitant estate taxes based on the value of that land, which I am sure today, because it is located i~i the middle of Columbia, would probably range in the neighborhood of a valuation of $4,000 or $5,000 per acre if not more? Mr. Chairman, I thank you very much for the opportunity to be here with you. The CHAIRMAN. Thank you, Mr. Byron. A~re thore~ auy questions? You have been very helpful and we appreciate your testimony. Mr. BURLESON. Mr. Chairman. The CHAIRMAN. Mr. Burleson. Mr. BURLESON. May I just say to our colleague from~1aryland. that he has been very active in this area, be has contributed a great deal to shaping this legislation and has worked diligently to create interest in it. I appreciate very much his efforts. Mr. BYRON. Thank you. [The prepared statement follows:] STATEMuNT OF HoIr. 000DL0E E. EYEON, A Th~PRESENTATIVE IN CONOFESS FEOM TIlE STATE OF MARYLLNO~ Mr. Chairman; I thank ~ou for the Opport ItI of te~tif~ng t~d~ay On behalf of an. 3832, the agricultural land estate taxation bill I introduced in the last Congress and this Congress. H I~ 88~2 has broad support it has ~5 co sponsors at the present timO In the U.S. House of Representatives representing a ~vIde nt~tnre of urban and rural constituencies as well as a diverse spectrum of states ~thd diutriets. H.R. 3832 is designed to address the problem of disapp~ar1ng open space and agrieultural land in this country We have all been following closely the vicissitudes in the world px~oduction of food The V S exports 73% of its wheat 50% of its rice, and 21% of its corn each y~a±. Eighty percent' of the~ world's soybean supply comes `fFoiii the United State~. Tue average Art~erican farmer produces enough to feed 53 people. But his mighty productivity in the agri~ cultural sector will not be enough if land is destroyed or irrevocably lost. PAGENO="0678" 664 The situationin Maryland regarding agricultural land is instructive. Accord- ing to the 1945 Census of Agriculture, the total area in Maryland farms stood at more than 4.2 million acres, or 67 percent of the State's land area. By 1969 this farm acreage had decreased to 2.8 million acres or 44 percent of the total land area, The 1974 report by the Maryland Committee on the Preservation of Agricultural Land estimated that the investment per farm in the 11,590 com- mercial farms in Maryland included $131,378 in real estate, $12,914 in machinery and equipment, and $8,717 iti poultry and livestock for a total of $153,009 per farm excluding inventOries `of feed and supplies. By 1986 total investment per farm will reach an estimated $438,000. The impact of inflation and population pressures on land is obvious from these figures. The real estate component of farm values is rising in absolute terms and as a percentage of overall farm value. Incidentally, in 1969 ~tbout 87 percent of the commercial farms in Maryland were operated as individual or fathily organizations. Only 11.5 percent were operated as corporations including family-owned corporations. There has been a continuing decrease In the percentage of land in farms. The State study projected that by the year 2000, the total land in the State in farms will be approximately 1.0 to 1.3 million acres or 19.6 percent of the State's area-a highly significant decrease from the 67 percent In 1945. The States have moved on the question of preserving agricultural land in the past two decades. Use value assessments are in effect in Connecticut, New Jersey, Washington, and Oregon. Other plans have been considered in Vermont, New York, Michigan and Hawaij. I would like to make abrief comparison between the bill, II.R. 1793, introduced by Congressman Burleson and H.R 3832. The first difference is obvious. H.R. 3832 does not include any increase in exemptions for estate tax purposes, nor does it increase the estate tax marital deduction. In the section dealing with alternate valuation, the first major difference is In the definition of qualified real property. The first three categories of qualified real property are essentially the same however, H.R. 1793 omits the fourth category-name~y properties lisled on the National Register of Historic Places. H.R. 1793 also allows th~ avoidàncç~ o~ taxes after 5 years should the property be sOld or converted, and it does nQt require the payment of interest on the additional taxes based on revôcatioil. These are important differences which I feel should be considered. In, closing, I would ll1~e to say that I cannot imagine a higher priority than preserving our agricultural land. The present federal estate tax structure has done much to hasten the saleand conversion of agricultural land in every corner of the country. This canuot contlni~e for long. If it dOes, we will all be the poorer--not just the citizens of this ~out1try but the entire world. Land is our most precious heritage. We have an opportunity in this Congress to rectify this situation and to show the American family farmer that his plight is recognized in Washington and that the warning signals are being heeded. 1 urge your favorable consideration of this landmark legislation, and I would hope that the House also will have an opportunity to consider such a bill in this session. The CHAIRMAN. Thank you, Mr. Byron. Our next witness is also froni~bryland, our colleague, Mr. Robert E. Bauman. Welcome to the committee. Without objection, your full statement will appear in the record as though read,, and you may proceed, sir. STATEMENT OP HON. ROBERT E. EAUMAN, A REPRESENTATIVE IN CONGRESS PROM THE STATE OP MARYLAND Mr. BAUMAN. I w~l1 only summarize my statement briefly, l~ecause I thin~t the gentlemen who have preceded me have amply demonstrated the problem we have today. As the gentleman `from Pennsylvania, Mr. Schneebeli, previously Observed th~~roblem of, estate taxation of agricultural land is parti- cularly~acute in the Eastern Unit~d' St~ates. You know, with only 3 to 4 percent of the American people engaged in agriculture feeding all of PAGENO="0679" 665 the United States and a good part of the world, we must do every~ thing we can in the Congress to reform our laws, to preserve the small part of our population that provides so much for us and for so many millions beyond our borders. `l'he problem that I face in my congressional district is particularly acute, and I brought along a map of Maryland just to demonstrate to you exactly what the problem is. If I can ask you for a moment in your mind's eye to envision the megalopolis that stretches from Boston to Richmond, Va., one long corridor, the State of Maryland has very luckily in many espects been spared the kind of development that this whole corridor has. My con- gressional district stretehes from this portion which is 20 miles from Baltimore City, north of Baltimore, nil the way down including nine counties of the Eastern Shore of Maryland, bordering on Delaware, the famous Mason-Dixon line, and three counties of southern Maryland. The Dejmarva Peninsula is the last relaitvely unspoiled area of the entire east coast megalopolis that I have described. What we have seen happening in the 55 percent of the State of Maryland that I represent is tremendous pressure placed upon our farm families and on real estate values. Here we have the cities of Philadelphia and Wil- mington and people are moving out in vast numbers, all sores of developments going up overnight. 1-lere we have the city of Baltimore. This pressure has moved into Harford County in my district, a rich dairy area. Here you have the city of Washington. You have Charles County. I suspect that half the policemen in the House staff live in Charles County. This is stretching down to St. Mary's County. There is rich agri- cultural land growing some of the best tobacco in the world. We have soybeans and corn in the north, and an acre that used to, go for a few hundred dollars is now selling for $1,500 to $3,000. A 2l/~acre plot next to my home in Easton, Md., where we have the added factor of the waterfront `was offered to me in 1969 when I got married for $15,000. It sold about a year ago for $52,000. Of course, it is rich farm- land `but it `also happens to be on the waterfront. I can only tell, you that the figures that Congressman Byron has demonstrated to yoi~i show not only t'h~ rapid drt~p in an Eastern State. of the total acreage but the tremendous difficulty this presents to,heirs when they are faced with the decision of should they go on farming or should they sell out to the `developm~nt' thterests that are waiting very eagerly to rake over. As ~a member of the Interior `Committee, I have fought against Federal l'and use legislation. Our `committee defeated it by `four or five votes in this sess~oii and a year or so âg~ `in the previous Congress land' use ~vas voted down. I would `like to suggest to your committee `that you have the power in your `hands' to impose a sort of Federal land use of the most attrac- tive kind-voluntary preservation of farmland throug~h intelligent planning for `future `heirs. ` , `That is what you can accomplish either with the Burleson bill, which I `cosponsor, or `Mr. Byron's bill, `lie time ha's come, the idea is, I think, the `right one, and I am `pleased that your committee has taken time to consider it. PAGENO="0680" 666 The CHAIRMAN. Thank you very much, Mr. l3auman, for a very helpful statement. Mr. Corman. Mr. `CORMAN. Congressman, do you have any idea about this urban sprawl? How many pieces of property turn over as a result of the sale by a living landowner and how many are turned over as a result of the death of the landowner? Mr. BAUMAN. You are asking me to compare speculation versus actual passing on to heirs? Mr. CORMAN. Yes. In other words, I have a feeling that somthody is expecting too much of us if they expect us to stop urban sprawl merely by changing inheritance taxes. I have heard this now from all of my colleagues from Maryland in both the Senate and the House, that somehow if ~we do away with or if we substantially change inheritance taxes we will stop urban sprawl. I am not quite sure that this proposed solution is that potent. Mr. BAUMAN. I would tend to agree with the gentleman from Cali- fornia that there is no way that we are going to be able to contain the movement and expansion of people from the metropolitan areas to the ex-urban areas which, as I explained, is the experience in my district. There are a number of farmers who do not want to sell out to devel- opment and they would much prefer to continue in the occupation of their ancestors and would like to remain on the farms, but the young people to whom I talk in my district, the kind who are faced with these decisions once the father or mother dies, literally have no choice. They are taxed off their farms. The choice has been made for them by a law that is obviously antiquated and needs change. I don't think we are going to revolutionize and reverse trends that are somewhat inevitable. Mr. Com~w~. Thank you. [The prepared statement follows:] STATEMENT oF Hox. ROBERT E. BAUMAN, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF MARYLAND Mr. Chairman, I would like to thank you and the other distinguished Members of the Ways and Means Committee for this opportunity to testify on behalf of two bills I have co-sponsored, H.R. 3831 and ER. 11770 which are both before your Committee. These bills and related legislation reform the present tax system by increasing the standard estate tax exemption to reflect the e~ects of ipflation since the $60,000 exemption was first set, and provides for the valuation of farmland and open spaces at levels reflecting their current use rather than the so-called "fair market value," an ailbitrary synonym for "highest possible use." K~bv1ously, Mr. Chairman, I feel that such reform is necessary. The present system Is hopelessly outmoded. The laws covering taxation of estates and gifts have not been materially changed since 1942, while the rates of inflation and sky-rocketing landcosts have. The resulting pr~blems have become burdensome to us all, and no combination of plagues and droughts equal the disastrous effect inflation has had on the American farmer, effects which are all too visible. Within the last two decades, our nation has lost more than two million farms. The American farmer is the most knowledgeable, efficient and indus- trious agricultural producer In the world. Four percent of our population feed all Americans and much of the wOrld beyond. Farmers spend more time and more money replenishing the earth than all the Independent and federal environ- mental agencies combined, and yet our system is forcing him to become an endangered species. PAGENO="0681" 667 The present tat system forces a farmer's heir to sell hi~ land arid lose his very livelihood in order to pay the estate tax liability Increased Interest rates on deferred payments and increasingly shortened deferral periods only work to fully secure his misery and guarantee his extinction or atthe very best, guaran- tee his impressment `by a federally supported lending compapy. How perfect for the `bicentennial Serf-farmers in what we like to call primitive societies have rebelled against their own government for lees, but it is out of character for the American farmer to act so disloyally. Against an ancient tax system and what has the Image of being `an ineff~ctive or careless Congress, the farmer is left with no other resource but to fade away As the figure I have cited indicates, this is what they have done. And this is what they will keep on doing unless estate `tav reform is put in tune with times. Some have contended that this is not as gtoat a problem as It seems, arid until the early 1960's they were right. Until only recently, federal estate taxes were not large enough to pose a significant problem for owners of family-sise farms. However, over the last decade farm asSets have increased on an average scale from $42,~85 to $163,503-and this is just the mean average for a family farm. The cause, one must seek? An unprecedented Increase in wealth or real Income for the farmer? Wrong. Every f~trmer knows the cause. Inflation. Inflation has distorted the aetrial Income base and assessment level and results in a most serious impediment to the orderly traimsfer and operation of farms which is why I and many other Members who are closest to the citizens engaged in agriculture are here. Farmers are not asking for a hand-out. They are simply asking for the moderate level of reform included in the bills I have described. It is moderate betause It is reasonable. I~y permitting the $60,000 exemption to be raised to $200,000 we are only re establishing the basic exemption level to what it was in 1942 before the effects of inflation. That is, under current economic conditions, $200,000 has a little less' than $60,000 worth of purchasing power had back then. Moreover by valuing farm property according to existing use rather than the so-called "fair market value," we are able to put a stop to the practice of penalizing a young farmer who wants to continue the profession of his ancestors. ILather than developing ulcers, as farmers must, over liquidity worries, over the desperate search for cash to pay the taxman when all of a farmer's wealth Is invested iii machinery or buildings rather than stocks and bonds; instead of continuing `this unfair system, the legislation I have co-spodsored would make It possible to inherit and run a farm without having to file bankruptcy. `~s a final word, Mr. Chairman, I want to state my belief that this legislation certainly benefits farniowners, but it also stands in accordance with the principles on which our government was founded. Property rights are among the huthan rights essential to the preservation of a free society. If we really believe this, if we really hold that every American Is afforded the opportunity to' save, invest, spend and convey his earnings to his heirs as he so chooses, we will see instituted the kinds of reforms I have described to you this morning. The CtIAIIiMAN. Thank you very much, Mr. Bauman. Our next witness is our colleague from Iowa, Mr. Berkley l3edell. Welcome to the committee, Mr. Bedell. Without objection, your full statement will appear in the record as though read. You may proceed, sir. STATEMENT OP lION. BERKLE~ BEDELL, A REPRESENTATIVE IN CONGRESS PROM THE STATE OP IOWA Mr. BlrniiIL. Thank you, Mr. Chairman, I am grateful for this opportunity to appear before this distin- guisheci committee to discuss a subject which is of great concern to me and of great importance to American society, estate tax reform. I realize that your time is limited and I will keep my comments brief. There are two basic points I would like to emphasize. First, while I believe that our estate and gift taxes are generally among the most PAGENO="0682" 668 progressive on the books, I do feel very strongly that the current inheritance tax exemption for family farms and small businesses is unreasonably low and in many cases acts as a major obstacle to the continuation of such enterprises from generation to generation. Something must be done to prevent high estate taxes from making it economically unfeasible for heirs to continue the operations of their parents and, second, while some meaningful tax relief should be pro- vided to individuals who inherit and wish to personally manage such farms and businesses, great care must be taken to assure that such relief in fact serves this purpose and does not become just another tax loophole for the affluent in our society. I believe that this new objective can be accomplished by increasing the estate tax exemption from $~0,000 to $200,000 and by making eligibility for this exemption subject to certain criteria which would require that this tax relief be used primarily to perpetuate the family owned and operated farm or business. I have joined in cosponsoring legislation H.R. 6306 which I believe would achieve this goal in the case of the family farm. I would certainly support similar initiative for small business. At this point I would like to add that I am opposed to an across- the-board increase in estate tax exemption. I am one of those who might possibly have a sizable estate and I do not believe that we should be. passing legislation which would lower estate taxes for individuals such as myself. Thus, if the committee does see fit to make an increase in the estate tax exemption applicable to all individuals regardless of circumstances, I would hope that it will recommend an exemption which declines proportionate to the value of the estate past a certain point. If, for example, the committee should decide that the $200,000 exemption should apply on an estate of $1 million or less, that exemp- tion should be reduced on a sliding scale to $100,000 or a $2 million estate and zero dollars on an estate worth $3 million or mor~, a reduc- tion of $1 in exemption for every $10 in estate or any similar formula. In conclusion, let me point out that family farms and small busi- nesses have long been the backbone of the American economy. Yet, unfortunately, their contributions are often taken for granted and their needs overlooked. Today many such operations are in jeopardy because of high estate taxes. It is time to recognize the fact that our estate tax law is out- moded and in need of revision. I am pleased that this committee is facing this problem and I hope that we can enact reform legislation which will preserve the original congressional intent in that area while also bringing the estate tax more in line with contemporary economic reality. Thank you, Mr. Chairman and members of the committee. I appre- ciate your courtesy in hearing me today and I hope that the prepared statement will be entered in addition to my statement, sir. [The prepared statement follows:] STATEMENT OF HON. BERELEx BEDELL, A REPEE~ENTATIVE IN CONGRESS FROM THE STATE OF IOWA Mr. Chairman, I am grateful for this opportunity to appear today before the committee to discuss the need for reforms in our current estate tax laws as they affect family farms and small businesses. PAGENO="0683" 669 I have come here today primarily because~I' am one of a growing uumber of people deeply concerned by the decline of the uuuiber of sm3ll, ~axuiJy. owned and operated farn~ in America. Parallel with this 4ecline Is a pronounced trend toward increased dependency upon large~scale, corporate entities for our food production. It is estimated that some 200,000 to 400,000 farms will be lost over the next twenty years. According to a USDA study, the United' states could be reduced from a current level of 2.8 millIon producing farms' to 1 million unitsb~V the turn of the century. In my State of Iowa, in just two years from 1973 to 1975, the number of producing farms dropped by 2,000 (from 189,000 to 137,000), while the land lu farms remained steady at 34.3 million acres. At question here Is not only the centralization of vital food produ~tion within a fewer number of hands, but the very preservation of a way of life. For too long, the federal government has overlooked the needs' of the fnmlly farm, and we are now seeing the signs of this neglect. Since tl~e early 1940's, when the current $60,000 estate tax exemption was set, the number of farm operators has fallen from 6.35 million to 2.82 mIllion in 1974. This displacement of farm population does not benefit the American consumer nor future generations of rural yoUth who will not have the ppportuntty of farming on their own. In spite of all our teciinplogical advances in agriculture, we must still rely on the care and commitment which only' tue Independent farmer can bring to his farm. Time after time, the family ~lzèd farm has been shown to be a more efficient means of production than l~rg~r èorporate enterprises. The family run farm Is in great jeopardy today, In part clue to the failure of federal tax law to keep pace with inflated agricultural land v~alues., Due to the illiquid nature of farm estates, sizeable estate taxes have forced farms out of family hands. According to the USDA, in 1972 there were 1 mIllion farms with assets In excess of $200,000. Of those, 600,000 farms were worth over $250,000 ahd 240,000 over $350,000. On the surface, these appear to be sizeable estates. Closer examina- tion reveals that the real value of most stiph fartns~iS in the soil, and reflect the dramatic nationwide rise in farm land prices over the past 30 years. Just in the last 12month period ending November 1, 1975, prIces for Iowa farm land rose an average of 30.8 percent to $989 per acre. I think it would be correct to sa~ that most farmers live poor and die rich. Clearly if we are to maintain family sized units as a basis of our agricultural production, we must remove the burdens placed upon heirs who wish to maintain the farm. At the same time, we must be very careful not to create another loop- hole available to the wealthy, or the geUtleman farm.~r. I am one who believes that generally our estate and gift taxes are among the most progressive on the books, and should be maintained at current levels except for the legitimate family- sized farm or small business. That is why I have co-sponsored legislation, aiong with many of my colleagUes, which would raise the current exemption from the current $60,000 to a level of $200,000, which more accurately reflects today's agricultural land values. [low- ever, this exemption would be available only to those heirs who either personally farm or operate the family business for a period of at least five years~ Under this proposal, an heir must reside upon the inherited farm, and maintain it as a working farm for that time period. Under this proposal, H.R. 6306 "The Family Farm: Inheritance Act," other assets of an estate not directly related to the actual family farming operation, would not qualify for the increased exemption. The five year provision and the limit on qualifying assets will, in my view, discourage wealthy non-farmers from using Such~ an Increased exemption as a shelter from estate taxes. I believe it als~ effectively prevents corporate farming operations from taking advantage of It. I believe that such an increase in the exemption should be allowed for small, family owned businesses, with similar prcs~isions limiting qualification to family- run businesses of a limited size in terms of assessed valiuttion and number of employees. ` Congress Included the estate tax exemption With these specific goals in mind, and through the years economic conditions, primarily agricultural land values, have greatly diluted the exemption's impact upon 0th- society. I am pleased that the committee is looking Into this problem, and it is m~ hope that we can a~t PAGENO="0684" 670 on new legislation which achieves the original Congressional Intent in light of today's economic realities. Thank you, Mr. Chairman, and members of the committee. Again, I appreciate your courtesy in hearing me today, and I would be more than happy to answer ~any questions you may have. The CHAIR~tAN. Thank you, Mr. Bedell. Your prepared statement will appear in the record. We appreciate your views. Mr. Conable. Mr. OO~ABLE. Thank you for your thoughtful contribution, Mr. Beclell. I wonder if the purpose that you advance-~~-giving relief to the small farmer or small .bu~hiess owner without benefiting the very wealthy-couldn't be achieved by converting the exemption to a credit against the tax? Mr. BRDZLL. Certainly, I think wherever we can use credits instead of exemptions it is preferabk~ because it does aid those with the smaller incomes to a greater proportion than those with high. Mr. CONABLE. Thank you. The `CHAIRMAN. Yes, Mr. Vander Veen. Mr. VANDER VEEN. Mr. Chairman. I would like to commend our colleague from Iowa for his contribution and his statements and I am particularly interested in his comments about trying in whatever we do to restrict the benefits of this as much as possible to preserving small businessesand family farms, He can speak with some authority on this subject and as it might apply to him personally and for that reason especially I commend his stand and I hope that the committee will take his views into considera- tion. Thank you. The CHAIRMAN. Mr. Stark. Mr. STARK. I would like to commend my colleague from Iowa for his comments, particularly with his reference to seeing that wealthy people don't just benefit by this. But I am somewhat puzzled: Let's say that we are talking about a modest sized farm-I guess that would be worth $200,000, or a small bsuiness-but then let's talk about a small auto agency or farm implement business in a similar town, say, in Iowa again where the business is worth $200,000. If it is owned by a person about our age or as young as we are with three or four children and he dies there would be a problem in that it is not liquid, and they can't pay the estate tax of perhaps $40,000. They don't have it, whereas somebody who may have come to Congress or decided to sell his business and has an incidental business of $200,000 worth of Texaco stock that pays $~Ui,00Q a year in dividends could easily sell a part of that estate to pay the taxes and all that would happen is that they would have $160,000 worth of stock and their income would drop to about $120,000 so that they have more flexibility than ~he small business person? Mr. BEDELL. Yes, that is correct. Mr. STARK. I cannot understand why it should not be sufficient to allow this owner of the small business or the small farm better terms. There is not a businessman in the world today who could say that a loan at 6 percent or 7 percent over 10 or 15 years isn't the best bargain. I know some people perhaps who would die to get that kind of loan PAGENO="0685" 671 from the Government. Just let them pay over the lon~cst., easiest terms manageable so that we can clearly solve their liquidity probler, and then we could deal with everybody on a fair basis in estate taxe~. The only unique problem to small farms or a~iy other small business, it seems to me, is the lack of liquidity which, people who have their investments in other forms have. If we could deal in a really reasonable way to exthnd good terms to those people, I think we could solve the problem. ,I wonder whether you would have any feelings about that kind of alternative? Mr. BEDELL. Well, as~an alternative I qnestion it because you men~ tioned a $200,00& farm or $00,000 busine~s. If we raised the exemption from $60,000 to $200,000, of ëourse we have solved that problem be'- cause they do not have an estate tax to pay. Mr. STARK. What about a person with' ~200,000 worth of stocks and bonds? Should he be exempt? Mr. BED1~LL. The legislation that I support says that in order for the heir to get the exemption, for the exemption to be applicable, the heir would have to live on the farm and operate `it or operate the family business so that in this case á~t least in the legislation I support it takes care of that problem about which you speak. If you want to add some possibility which I think is already there covering the case where you cannot pay, I am no tax expert but' it is my understanding that if you are not able to pay your taxes you can get a deferral and there is interest charged. Mr~ STARK. I was trying to think of the fairness to the person who sold his place and has $200,000 in stock and the person who still holds the business. I don't understand why it is fair to penalize the person who sold his business, who paid a. capital gain, who ends ~p with $200,000 in stock and the person ~ho has maybe a $1 ndllion farm with a mortgage and $200,000 of equity in it~-why one pays no inheritance tax and the other has to pay. How do you explain that to the children? That bothers me. Mr BEnEu~ I am extremely pleased that you brought that up I don't want to take too much time but I ~*ould like you to know my feeling on that matter It is my feeling that the real reason that th~~ change in our tax laws is so important `is because of the itnporta~ce of the family farm and small business to our total society. I think we are seeing a loss of our family fa~rms and small business in our Society and I think:it is very, very mueh~ in the interest of o~r total society that we do what we can to make it possible for that to continue. If you are talking about the fairness to the individual,'there I think you maybe have some point. Everybody doe~n't agree with me but I have to tell you that my opinion is that'we say we have a land where we have equal opportunity for all. The fact is we don't. The fact is that my child~en, `if they osh inherit large amounts of money have op- portunities that are not available to some other individu~i~ as far as I am concerned, as I look at it. , So `that what I am really trying~to attack, and, whet I believe is the real isSue here as whether or not we are going to have a society where small operators, if th'e.y~ wish to contirme thet op~ratiou within their family, will have an opportunity to do so. PAGENO="0686" 672 So for me it would make quite a difference whether that farm was passed on to an heir within the family who is going to operate it or whether it was sold to some big corporation and then the money that was available from that stock was left to the heir. Mr. STARK. Would you feel the same compassion for the operator a small apa.rtment house or the person who invests in a small way in the stock market? Mr. BEnELL. I would not feel the same way in the stock market. If it is a rental proper~ty which is a family business I would agree. The difference is, as I see it, that if you are operating a farm, if you are operating a small business, if you are operating an apartment house, you are involved in working to see that that is done. If you have stock in the stock market, you are busy clipping coupons and I think there is quite a difference. Mr. STARK. Would you favor limiting the amount of outside income the heirs could have to get this treatment? In other words could the test be if they depeiided solely on the farm for income so that you don't have somebody making $50,000 a year as an accountant and operating the family farm as a hobby? Mr. BErn~LL. As a policy I would. I think sometimes we get our leg- islation so ebmplic~ted but I would otherwise. Mr. STARK. Thank you. The ChAIRMAN. Mr. Fisher. Mr. FIsuEI~. Thank you, Mr. Chairman. I want to compliment our colleague from Iowa for bringing very clearly to our attention what is the main issue here and you have just stated it. It is do we wish, through lifting the exemption, to strike a small blow for preservation of the smaller family sized enterprises in America? Obviously by lifting the exemption we are going to lose revenue. Obviously we. are going to reduce equity viewed in a certain way. The advantage is what you point to and that is really all the ad- vantage. There isn't any other that I can see. It does enable the smaller enterprises, the farm or small business or whatever, to go from gen- eration to generation or one person to an heir with a fairly good chance of being sustained. I think this has to be kept right in the center of the table all the time because I agree with the gentleman. 1 see no other justification for this. It seems to me, Mr. Bedell, that the essential thing is that all the rest of the people who participate in the national economy be fully assured that with a higher exemption and protection for the family sized enterprise that that enterprise does remain a family enterprise for a long period of time. Therefore, I want to ask you what you think of not limiting this to ~ years, which is a very short time in the life of a farm or the life of a person, not limiting the operation of this to 5 years, but extending it for a generation of time, say 25 years, so that if the enterprise is sold, no longer operated by the farm family or the small business family, they would have to go back then and pay the estate tax that they would have had to pay, plus interest. PAGENO="0687" 673 ,I am seeking to find a way to conform to the main objective that you and I an4 others have, and yet protecting all of us for a long, long period of time against any subversion of that objective. So I wonder what you think of extending that period. Mr. BEDELI~. Well, this is off the cuff and I have not had a chance to really study your proposal. I think I would tend to be somewhat concerned about interest charges therein because I `think over a long period of time, as you know, compound interest can amount to tremend- ous amounts of money. I would not have any argument with the gen- eral concept. I guess there are a lot of things you would want to look at. For example, would it be possible for that member of the family then to pass it on to other members of the family? As you know, we have some inequities today in our inheritance tax law depending on whether it is the wife or husband who dies in the case of a family farm where both of them actually contribute similarly to the develop- ment of the farm. I would have the concern of supposing the person that inherited the farm came on the farm and proved really not to be a very capable farmer. Then would there be an opportunity to pass it on to other members of the family or how would you handle it? My answer is I have no problem with the concept. I would have some question about how you would handle it. Mr. FISHER. My response to that, I suppose would be that so long as it remains a family size small operation it could be passed along with- out having to go back and pick up the estate tax or any interest, that that is the value we are trying to preserve here and we are trying to preserve it in such a way that it cannot be subverted by dilettante farmers or people seeking a loophole for a few years. Perhaps the length of a normal generation is a reasonable length of time, say 25 years. Mr. BEDELL. It is certainly a concept. We share the same concept. It is to maintain the family farm or family business and keep it a viable part of our society. As to how we would do it, I don't know. Mr. FISHER. There will be those, of course, who don't accept the social value that perhaps you and I see in the small family enterprise. That is a legitimate point of view that will have to be explored. But I do thank you for focusing very clearly on what I regard, as the main issue. Mr. STErnER. Mr. Chairman. Mr. BunLEso~ [presiding]. Mr. Steiger. Mr. S~rEIuEa. Mr. Chairman, I am fascinated by the exchange which has just taken place. If we go the route you suggest, Mr. Bedell, or the route Joe Fisher has proposed we will be encouraging preservation forever, regardless of merit or economic viability. We would be carving out for a particular segment some kind of benefit. If I can ask our colleague from Iowa, what happens to the case that I remember well in Oshkosh, Wis., of the employee of Sears, Roebuck who happened to be the janitor at the Oshkosh Sears store. He died 7 or 8 years ago and through the Sears profit-sharing plan he accumu- lated an estate of almost $200,000? Are we to penalize that person because he did not own his business but worked hard and saved his money and was fortunate to invest in PAGENO="0688" 674 the stock of his company? Do you really want to create that kind of a systeni~-to remove the incentive for an individual who wants to see his family enjoy the benefit of his labor? Mr. BEDELL. May I speak to that? Mr. Smioi~n. Of course. Mr. B1~ar4L. We all have different opinions about our society. You see, it is my opinion that his work there and his success accrued to him during his lifetime and was helpful to him. He had children just as Mr. Fisher might have children and I might have children. Those children happened to be born to him or happened to be born to me or happened to be born to Mr. Fisher or whoever else it may be. What we are talking about are the inequities, in my opinion, not to that person-he is dead-who worked for Sears, Roebuck; we are talking about the inequities to those children who were born and, whether we like it or not, those inequities exist in our society. They do exist because, if you are a wealthy individual, your children do have benefits, and the children of that employee of Sears, Roebuck did receive benefits even with the exemptions not in and everything else. He received an estate that was not available to many of the people withiu our society. So I think we have that. I think what we are trying to do with this legislation is exactly what Mr. Fisher put his finger on. I think we are trying to preserve a type of a society which will help us to have a better type of life here, and this is a philosophical difference that we may have. Mr. S~rsTGrAn. There isn't a philosophical difference at all. I am all for trying to find a method by which on equitably preserves. What you have suggested however, would create a system that is singularly in- equitable; you say the guy that runs the machine shop or automobile agency or fish and fly manufacturing company gets a benefit because he is in a "small business." The individual who does not own a business but who, through his own work and through his own good luck and whatever other reason, enjoys an identical-size estate would find him- self being taxed more heavily than the person across the street who owned a business. That seems. to me really inequitable. Mr. FnENZEL. Would the gentleman yield? Mr. S~n~mm~n. Yes. Mr. FRENZEL. I would like to carry the inequity point further. Sup- pose you the farmer's second son and get left $100,000 worth of securities and the older one gets the farm. Can you justify the first one's getting a greater benefit than the second? Mr. BEDELL. No. I think Mr. Steiger's point is a mistake we make in our total thinking on this subject-that is, that we talk about what is fair to the person whose estate it is who is dead and gone. It seems to me we have to look at what is fair to the people who are doing the inherit- ing, who are left and living. It seems to me that those are the ones that we have to look at as we try to establish this fairness. I think Mr. Frenzel has a very good point there because I think that the only way that it could be done here fairly-and this is that oppor- tunity to make it fair-the father or whoever it is ~ho leaves the estate certainly knows what the taxes are going to be on the estate; and if I were the father and were leaving a farm to one of my people and leav- ~ng stocks to one of the others of my heirs, I would leave. mor~ in PAGENO="0689" 675 stocks to the other heir if I knew that taxes were going to be greater, so that I had the opportunity to make it fair to both of those heirs. Mr. F'RENZEL. Let me come at you in another way. In my State the family farn~dng corporation has become quite popular. Suppose you are a minority owner in the family farm corporation and don't hap- pen to be rwaning the farm or maybe after 41/2 years you get kicked out by the majority ownership. Then are you liable to inheritance taxes? I think you are setting up a kind of class here that is going to be hard for you to defend both in equity and in law, and maybe con- stitutionally as well. Mr. BED~LL, I am not a lawyer. I would not pretend to know what I could defend in law or what I could nOt. I really feel very strongly that I think we are here to try to build the best sdcfety here in America that we can and, as we do that, I think we have to look at what is im- portant to our society and I feel very, very strongly that if we continue to move where ~e h&ve fewer and fewer great big entities controlling our total society, we are not moving toward the better quality of life that I think we would like to see in our society, and I think we need to do what we can to make it possible to try to preserve the opportuni- ties for those small operators. Granted there are some inequities and those ineqiuties were not true when our forefathers came over because there was plenty of land and we could haive a homestead available to everyone, but unfortunately today we don't have that extra land. It seems to me that we should do what we can to try to at least main- tain that type of sociey to the best extent that we can. Mr. VANDER VEEN. Would the gentleman from Wisconsin yield? Mr. S~rnma. Yes. Mr. VAiorn V~x. Mr. Bedeli doesn't need any help whatsoever in making his point. He has made it very well. I would like to point one thing out. There is, Mr. Frenzel brought up a case of the effect of the inheritance tax in his State. To my knowledge every State has an in- heritance tax. That is a tax that is imposed upon `the recipients of the property in an estate whereas the estate tax, the FCderal estate tax with which we are concerned here in this committee,, is a tax which is not imposed upon the recipients of the estate. It is a tax which applies to the estate. The recipients as not liable for the tax. So I think that in our discussion, in our thinking about this prob- lem, that it is an essential point to remember. `Mr. FEENZEL. If the gentleman will yield, I would like to thank the gentleman for clearing that up, but the estate would still have the problem where it gave a farm to one and stock to `another, and really I was trying to simplify what is a very complex question. We didn't talk a bit about the minority operator or minority owner in a small business who is not able to pass control of the business, afid that, of course, gets even more complicated. I think it is just as illustrative of the point that I was trying to make. It is just not all that e'a~y to say that we are going to make life different or preserve a farm value without stomping on a lot of other rights. Although I think you ar& correct in saying that the gentleman from Iowa has been very helpful and has made his case very success- fully, I think the point Mr. Steiger and I were trying to make is' that it ain't all that easy. 68-872-76----44 PAGENO="0690" 676 Mr. VANDER VEEN. If I may just respond to that, you are absolutely right. It is not easy at all unless we confine our objective to trying to preserve the family business or the family farm. That I don't think will be so difficult. But if we are trying to extend that idea to people who have substantial estates regardless of what the assets of those estates are, then I agree with you that it becomes complicated. Mr. B1IRLES0N. Are there other questions for Mr. Bedell? If not, thank you very much for coming before the committee. Mr. BEDELL. Thank you. Mr. Bu1u~EsoN. Our next witness is another colleague from the State of Iowa, Mr. Grassley. We are pleased to have you, Mr. Grassley. You may proceed. If you wish to summarize, your full statement will be included in the record. STATEMENT OP HON. CHARLES E. GRASSLEY, A REPRESENTATIVE IN CONGRESS PROM THE STATE OP IOWA Mr. GRASSLEY. Thank you. Mr. Chairman and members of the Ways and Means Committee, small farms and businesses have played an im- portant role in American history and in the American economy. They have induced the tremendous economic growth that America has ex- perienced since its inception. They have insured that our economy be competitive. And they have given millions of Americans the oppor- tunity to utilize their own initiative and intelligence to build meaning- ful lives for themselves. In short, almost all that has made America the strong and pros- perous Nation that it is can be directly attributed to small American farms and businesses. And today, with more than 5 million businesses and about 3 million farms, many of them small, they are continuing to play this important rolethat they have always played. TJn~fortunately though, the very existence of these farms and busi- nesses is now threatened by the Federal estate tax. This tax imposes such enormous burdens on the heirs of estates that in many cases it can bepaid only by selling part or all of the estate. The impact of this tax is alarming. In 1950 there were 5.6 million American farms; in 1959, 4 million; and today only 2.8 million. Simi- larly, the number of businesses has drastically declined. The estate tax has been responsible for a large part of this development. What these cold facts mean is that millions of Americans have been forced to abandon their farms and businesses, to seek entirely new ways of life, simply because they cannot afford to pay this tax. Precisely how does the estate tax impose its burden? First, only $60,000 of an estate is exempt from the tax. While this amount might seem to be very generous it is grossly unfair in the light of changing economic conditions. The $60,000 exemption was established in 1942, 34 years ago. Simply accounting for inflation a farm or business that was worth $60,000 in 1942 would now be valued at $210,000. As a result, the proportion of estates paying the estate tax has in- creased from 1 percent in 1942 to 11 percent today. Each year more and more farm and business estates are subject to this burdensome tax. And these farms and businesses are not simply the wealthy estates. Farmers and businessmen who have never earned more than $4,000 PAGENO="0691" 677 or $5,000 a year could easily accumulate an estate worth much more than $60,000. This is especially tru~ of the farmer. With land values skyrocketing, a very modest farm of perhaps 160 acres very likely will be worth $200,000 or more. And, in fact, the average farm today is worth more than $200,000. Thi2ts the $60,000 exemption hurts all farmers and businessmen, not just the wealthy bnes. Second, in the case of property passing from the deceased to his lawful spouse, a marital deduction is allowed of up to 50 percent of the value of the estate. But when the estate is relatively modest and especially when the surviving spouse has dependents, the estate tax imposes undue hardship, forcing the spouse to sell part or all of the estate to pay the taxes. The marital deduction in such cases simply does not provide sufficient protection. Third, if real estate is part of the estate it is assessed at market value rather than current use value. Since market value is fr~qnently inflated or exaggerated relative to use value due to land speculation and the demands of urban sprawl, this type of assessment penalizes the farmer or businessman whose property might be worth substan- tially more for another purpose. Again this forces many heirs to dispose of their property. Finally, when farmers and businessmen hold their property in joint tenancy the entire value of the estate will be taxed unless the surviving tenant can prove that she or he contributed part of the money for the purchase of the property. Obviously this provision discriminates against housewives and other persons who might very well have contributed to the purchase by pro- viding services but, since they never worked for a wage, they cannot demonstrate their eligibility for a smaller taxable estate. This has also contributed to the decline in the number of farms and businesses. Because of these four factors farms and businesses have been aban- doned, split up, sold to other farmers and businessmen or to third par- ties. This effect has been substantiated by at least four studies in the past 20 years. In 1957 a survey of 76 Iowa farm landowners revealed that if each of the landowners were to die on the day of the survey, 91 percent would not have sufficient liquid assets to pay the estate taxes. In 1963 Brown University published the results of a study of firms that were sold or merged from 1955 to 1959. It concluded that estate taxes were responsible in 60 percent of the cases. A 1974 study of Iowa farm estates generated a similar conclusion. And a recent tT.S. Dejartment of Agriculture study indicated that 25 percent of all es- tates containing real estate were sold at the time of the owner's death to pay the estate taxes. At this point, I want to make reference to the fact that the bill that I am sponsoring and I do not mean to take any credit away from Mr. Burleson because he deserves all the credit, is the same as the bill Mr. Burleson introduced except that mine makes it easier for the spouse to get credit for contributing to the increase in value of the estate over the years. These reforms will substantially ease the burden that the estate tax imposes on the heirs of farms and businesses. These reforms have not been arbitrarily fashioned simply to pro- iride a tax break for farms and businesses; instead, they reflect a genu- PAGENO="0692" 678 me concern to make the estate tax an equitable tax. Consideration of inflation during the past 30 years demands that the exemption be $200,000, not $60,000. If the needs of surviving spouses with dependent children are noted, then the marital deduction should be increased. That all other property taxes use current use ~value and not market value for tax assessment is an important reason for changing the es- tate tax's basis for assessment. And, of course, it is about time that the worth of housewives and other unpaid service workers be recog- nized by the tax laws. Thus, if my proposal, H.R. 12424, is adopted, it will change the estate tax in two fundamental respects: first, it will reduce its burden on farms and businesses, and, second, it will make it more equitable. These changes will insure that the small farms and businesses that have played such an important role in our history and in our economy will continue to have an opportunity to ~endure and prosper. This will benefit all Americans, not just those who happen to have inherited an estate. Thank you, Mr. Chairman. Mr. BTJRTIESON. Thank you, Mr. Grassley. Mr. Conable will inquire. Mr. CONABLE. I welcome our colleague from Iowa, and appreciate his presenting us with the viewpoint which must be held by the great majority of the people of his area. We happen to bow that a great deal of the pressure for this reform comes from the Midwest because of the peculiar problems of land ownership and small business farm- ing in that area. So it is entirely appropriate for him to come and give that viewpoint to us at this time. Thank you. Mr. GRASSLEY. Thank you, Mr. Conable. Mr. BURLESON. Are there other questions for Mr. Grassley? If not, thank you very much for your contribution tothis subject. Mr. GRASSLEY. Thank you. [The prepared statement follows:] STATEMENT OF HON. CHARLES E. GRASSLEY, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF IOWA Small farms and businesses have played an important role in American history and in the American economy. They have induced the tremendous economic growth that America has experienced since Its inception. They have insured that our economy be competitive. And they have given millions of Americans the opportunity to utilize their own initiative and intelligence to build meaningful lives for themselves. In short, almost all that has made America the strong and prosperous nation that it is, can be directly attributed to small American farms and businesses. And today, with more than 5 million businesses and about 3 million farms, many of them small, they are continuing to play this important role. Unfortunately, though, the very existence of these farms and businesses is now threatened by the Federal estate tax. This tax imposes such enormous burdens on the heirs of estates, that in many cases It can only be paid by selling part or all of the estate. The impact of this tax is alarming: In 1950 there were 5.6 million American farms; in 1959, 4 million; and today, only 2.8 million. Simi- larly, the number of businesses has drastically declined. The estate tax has been responsible for a large part of this development. What these cold facts mean, is that millions o1~ Americans have been forced to abandon their farms and businesses-to seek entirely new ways of life-simply because they cannot afford to pay this tax. PrOcisely how does the estate tax impose its burden? First, only $60,000 of an estate is exempt from the tax. While this amount might seem to be very generous, PAGENO="0693" 679 it is grossly unfair lii light yf chan~1n~ economic conditions. The $60,000 ~xemp~ tion was established In 1942-34' years ago. Simply accountlr~g for Inflation, a farrti or business that was worth $60,QQ0 In 1G42 ~ul4 now be vaIne~l ~t $210,000. As a result, the ~>roport1on of estates paying the estate tax bos Increased ~nom 1% in 1942 tQ 11% tqday. lDeh year more an4 more far~n and busj~ies~ e~tates are subject to i~hi~ burdeasome taz. ~nd these fa~m~s and busjues~es are nqt simply the w~al~by est~tes. F~rn~ers and businessmen ~crho have never eaimed more than fouror five thousand dollars a year ceuld easily accumulate ~`~tate wartb much more than $60,000. Thi~ Is especially true of the farmer. With land values skyrocketing, a very modest farm-160 acres-very likely will be worth $200,000 or more~ And, In fact, the average farm today 1$ worth ~nore than $200,000.. Tbu~, the $60,000 e~emptlon hurts all farmers and businessmen, not just the wealthy olies. Second, in the case of property passing from the deç3ea~ed to his lawful spouse, a marital deduction is allowed oct~ up to 50% of the value ~f the estate. But when the estate is relatively modest, and especially when the su~,rlving spouse has de~ penclents, the estate tax imposes undue hardship, forcing the spouse to sell part or all of the estate to meet the taxes. The maritt~l deduction in such cases simply does not provide sufficient protection. Third, If real estate `is part of the estate, it is a~sessed ~lt market value rather than current use value. Since market value is frequently inflated or exaggerated relative to use value, due to land speculation and the demand~ of urban spi~awl, this type of assessment penalizes the farmer or businessman whgse property might be worth substanUally more for another purpose. Again, this forces many heirs to dispose of their property. Finally, when farmers and businessmen hold their property In joint tenancy, the entire value of the estate will be taxed, unless the surviving tenant can prove that she or lie contributed part of the ~oney for the purchase ~f tl~ property. Obviously, this provision discriminates against housewives and other persons who might very well have contributed to the purchase by providing services, hut since they never worked for a wage, they cannot demonstrate their eligiblity for a smaller taxable estate. This has also contributed to the decline in the ~iumber of farms and businesses. These four factors have resulted in farms and businesses being abandoned, split up, sold to other farmers and businessmen, or to third parties. This `~ffeef has been substantiated by at least four studies in the past 20 years. In 1957"a survey of 76 Iowa farm landowners revç~lod that, If each of the landowners were to die on the day of the survey, ~1% would not have sumclent liquid assets to pay the estate taxes. In 1963, Brown tiniversity pttbiished the results of a study of firms that were sold or merged from 155 to 1959. It concluded that estate taxes were responsible In 60% of the cases. A 1974 study of Iowa farm estates generated a similar conclusion. And a recent United States Department of Agriculture study indicated that 25% of all estates coptaining real estate were sold at ~the time of the owner's death to pay the estate taxes. The cost of this effect is enormous. For the farmer's and businessmen who are forced to sell their estates, it is especially costly-economically and emotionally. For all Americans, since these economic units are generally efficient, any change in their size will `be translated into higher consumer prices. ~nd, since many farms and businesses are comtletely eliminated, the resultingly smaller supply of goods and services also creates higher prices. To eliminate this cost, I have.proposed (in IT.fl. 12424) that: 1. the exemption be increased from $60,000 to $200,000; 2. that the marital deduction be Increased to $100,000 plus 50% of the value of the estate; 3. that certain estates, Including farms, be assessed on a "current use" rather than a "market value" basis. 4. that services-such as those of `a housewife-be regarded ~s a monetary contribution in determining the taxable portion of an estate. These reforms will substantially ease the burden that the estate tax imposes on the heirs of farms and businesses. But it should be pointed out that these réform~ have not been arbitrarily fash- ioned simply t~ provide a tax break for farms and businesses; instead, they reflect a genuine concern to make the estate tax an equitable tax. Consideration of inflation during the past 30 years demands that the exemption be $200,000, not $60,000. If the needs of surviving spouses with dependent children are noted, PAGENO="0694" 6S0 then the marital deduction should be Increased. That all other property taxes use current use value and not market value for tax assessment is an important rea- son for changing the estate tax's basis for assessment. And, of course, it is about time that the worth of housewives and other unpaid service workers' be recog- nized by the tax laws. Thus, If my proposal (H,R. 12424) Is adopted it will rhange the estate tax in two fundamental respects: first, it will reduce its burden bn farms and businesses, and, second, it will make it more equitable. These changes will ensure that the small farms and businesses that have played such an important role in our his- tory and in our economy will contintie to have an opportunity to endure and prosper. This will benefit all Americans. Mr. BURLESON. Our next witness is oui~ colleague, Congresswoman Virginia Smith of Nebraska. We are glad to have you, Mrs. Smith. Thank you for coming. You may proceed. If you wish to summarize, your full statement will be placed in the record. STATEM]~NT 0F HON. VIRGINIA SMITH, A REPRESENTATIVE IN CONGRESS PROM THE STATE OP NEBRASKA Mrs. SMITH. Thank you. Mr. Chairman and members of the com- mittee: I am grateful for this opportun~ty to testify in support of the need to make significant reforms in our estate tax laws. During the time I have been in Congress, no other area of tax reform has generated as much interest and concern in the Third Congressional District of Nebraska as the estate tax. I have received hundreds of let- ters and petitions from my constituents asking that legislation be adopted as soon as possible to update the laws and make them more equitable. I seldom go to a meeting where this isn't the first matter that is brought up for discussion. Most of the letters and the questions come from people who own and operate family farms and ranches-~ many of them handed down from generation to generation. `1~hey want their children to be able to continue to keep them in the family and pass them on to their children, but under present estate tax laws, it is getting more difficult for the inheritors to keep a family farm intact. It is often necessary to sell part of the estate or deplete savings in order to pay the inheritance taxes. Because I agree that reforms must be enacted, early last year I intro- duced H.R. 4808, which is identical to or similar to other bills pending before your committee. It would amend the Internal Revenue Code to increase the Federal estate tax exemption; to increase the estate tax marital deduction; and the third provision of the bill I introduced would assess farm, woodland, or scenic openspace property for estate tax purposes on the basis of its current use rather than its higher potential uses. Based on what I hear from farm families in my district and from my own study of the estate tax laws, these are the inequities which need to be addressed. The economics of these proposed changes have been and will con- tinue to be documented by witnesses in these hearings. So I would just like to cite some of the hardships from specific examples as they have come to me day after day, which show what the current inflation and the spiraling land i~alues have done to farm and ranch owners. The son of a farm couple states in his letter tome: PAGENO="0695" 681 My parents have 480 acres of land which they purchased In the 1940's for a total of $13,700. The value of this land Is now esttthated to be between $193,000 and $240,000. We bate been told by an atto~rney that at the present time the estate tax would amount to upwards of $40,®0, Now, with our parents in rapidly failing health, we face the unpleasant probability of having to sell enough of the farm to make It an e~ective unit j~tst to pa~ the inheritance tax. A mother writes:, This quarter of land we live on was bought in the 1930s by my father-in-law for $7,000. We paid $28,000 for it in 1949 when the estate wa~ settled. Now, we don't dare quote $160,000 as it would be sold at o~nce. We would like to have our son bkve the farm some day, but with t~beritance taxes so high in this time of inflation, he doubts he could hold on to it. Another landowner expresses the problem this way: In my case I acquired my farm of three sections In Custer County during the years from 1941 to 1941! for $3~,000 and it is presently worth $355,000. The $60,- 000 inheritance exemption was established in 1942-~$60,000 Is to $35,500 as $600,000 is to $335,900. From a retired couple I hear: My husband and I are retired but still maintain an active interest in the ranch I was born on and grew up on. Our son and daughter-in-law and a single daugh- ter 36 years old still live on and maintain and work this ranch-and we hope it can continue as it has for the past three generations. in the na~ne of these heirs. The everyday preblems of the ranchers are knotty enough without the anxiety over who is to carry on the work at hand when the original owner passes on. Just yesterday I had a guest from the Third District of Nebraska. He told me they had to sell land that had been in their family 50 years because they couldn't raise money to pay the inheritance tax. These are just examples I. picked at random from hundreds of let- ters `I received. A recent issue of the Grand Island Independent cited yet another.. This one involved three sons who ended up paying 24 per- cent of the value of the land they inherited in inheritance taxes. On a net estate value of $378,000, the three paid a total of $115,016 in taxes to the Federal, State, and county governments. After taxes, the three sons, who inherited the estate equally, each had $88,000 portions of the estate, an individual amount less than the total inheritance tax paid to the Federal Government. Taken all together, these problems, I think, put the difficulty in sharp focus-our estate tax laws are woefully out of date and need to be revised. Dealing with this problem is the purpose of these hear- ~ngs, and we should expect, Mr. Chairman, that the preponderance of evidence placed before this committee will result in a tax reform bill going to the House of Representatives to correct inheritance tax in- equities. I need not remind the members of this committee that the failure to enact changes. in our inheritance tax laws will place the fnture of family farm operations in jeopardy. Our family farms have long been considered the heart of An-~erica's free enterprise system, symbolizing the best of our heritage and our independence. We feel they must be preserved if America's agriculture is going to continue to carry out its vital role of producing foOd and fiber for our needs as well as the needs of others beyond our shores. Revising the estate tax laws so that the farms can be passed on from generation to generation without an oppressive tax burden appears to me to be very much in order. PAGENO="0696" 682 Before I conclude my remarks, Mr. Chairman, it behooves me, as a Representative from Nebraska, to recognize a farm wife from my State who has *cloiie as mu~th or more than anjy on~ individual to call attention to the inequities in our estate tax laws. She is Mrs. Doris Royal, of Sarpy County, Nebr. 1*Then our es6até ta~ laws t~re change4, she will deserve a share of the credit. She and her colleagues have done much to bring the whole problem into sharp focus. I appreciate the opportunity to testify. Mr. Bmu~soN. Thank you very much. I believe Mrs. floyal is going to testify on the third panel. Mr. Conable. Mr. CONABLE. I thank Mrs. Smith for coming to the committee. I think it was very helpful to hear the letters she i'ead. I think we have all received similar letters. Certainly in a productive farm area like yours there must be great problems. Thank you. Mr. Buni.EsoN. Mr. Duncan. Mr. DUNCAN. I must say that I don't know anyone who represents their people better than you do in the I-louse. ~You have given a fine statement. Thank you. Mrs. SMITH. Thank you. I appreciate your comments. Mr. BURLESON. Are there other questions of Mrs. Smith? If not, I want to say that you have made a most impressive statement. Mrs. SMrPH. Thank you very much. [The prepared statement follows:] STATEMENT OT HoN. VIRGINIA SMITH, A REPRESENTATIVE IN CoNGRESS FROM THE STATE OT NEBRASKA Mr. Chairman, Members of the Ways and Means Committee: I am grateful for this opportunity to testify in support of the need to make significant reforms in our estate tax laws. During the time I have served in Congress, no other area of tax reform has generated as much interest and concern in the Third District of Nebraska as the estate tax. I have received hundreds of letters and petitions from my constitu- ents asking that legislation b~ adopted as soon as possible to update the laws and make them more equitable. These letters are from people who own and operate family farms and ranches-many of them handed down from generation to generation. Their owners want to continue to keep them in the family and pass them on to their children, but under present estate tax laws, it is getting more difficult for the inheritors t~ keep a family farm intact. It Is ofteil necessary to sell part of the estate or deplete savings in order to pay the inheritance taxes. Because I agree that reforms must be enacted, early last year I introduced HR. 4808, a bill which would amend the Internal Revenue Code to increase the Federal estate tax exemption; to increase the estate tax marital deduction; and to provide an alternate method of valuing certain real property for estate tax purposes. This bill is identical to, or similar In language to, other bills pending before the Committee. Specifically, it would increase the present exemption of $~0,000 to $200,000. It would also increasO the marital deduction from its present rate of 50% of the total value of the adjusted gross estate. The third provision of the bill I introduced would assess farm, woodland, or sëenic Open space prop- erty for estate tax purposes on the basis of current use rather than higher po- tential uses. Based on what I hear from farm families in my District and from my own study of the estate tax laws, these are the Inequities which need to be addressed. I think this is why, Mr. Chairman, so many of the bills before your `Oommlttee PAGENO="0697" 683 carry provisions to make speciflo changes on the order of what `ILR. 4808 reeommends. ~ Mr Chairman the economies of these propt~sed chattges have been and will continue to be documented by witnesses in these hearings. I could cite the same figures and give the same justification for correcting these serious inequities. Permit me however to present some of the actual examples ~f how the present estate tax laws work hardships because they are so out ef date, and do not take into ~ account the degree of inflation we have suft~ered and Its effect on spiraling land values. The son of a farm couple states in his letter to me : "My parents have 48O acres of land which they purchased in the 1940 s for a total of $13 700 The value of this land is now estimated to be between $198,000 and $240,000, We have been told by an attorney that at the present time the estate tax would amount to up- wards of $40,000. Now, with our parents in rapidly failing health, we face the unpleasant probability of having t&seil enough of the farm to make it an effec- tive unit just to pay the Inheritance tax." A mother writes: "Th13 quarter of land we live on was bought in the 1930's by my father-in4aw for $7,000. We paid $28,000 for it In 1949 when the estate was settled. Now, we don't dare quote $100,000 as It would be sOld at once. We would like to have our son have the farm some day, but with inheritance taxes so high in this time of inflation, he doubts he could hold on to it." Another landowner expresses the problem this way: "In my case, I acquired my farm of three sections In Custer County during the years from 1941 to 1947 for $35,500 and it is presently worth $355,000. The $60,000 inheritance exemp- tion was established in 1942-$6U,000 is t $8~,500 as $600;000 is to $335,000." From a retired couple, I hear: "My husband and I are retired but still main- tain an active Interest In the ranch I was born on and grew up on Our son and daughter in law and a single dauglfter 86 years old still live on and maintain and work this ranch-and we hope it can continue as It has for the past three generations In the name of their hdil~s The everyday problems Of the ranchers are knotty enough without the an~x~èty over who is to cái~ry on th&work at hand when the original owner passes on." These are just examples I picked at random fyoth hufldred~ of letters I re- ceived. A recent Issue of the Grand Island Independent cited yet another. This one Involved three sons who ended up paying 24 per cent of the value of the land they Inherited in Inheritance taxes On a net estate value of $378 000 the three paid a total of $115 016 In taxes to the Federal Otate and county gor ernments After taxes, the three sons who ipherited the estdtO eqii~tlly each had $88,000 portions ~f the e~tate, an individual amount lés~ than the tOtal in- heritance tax paid to the Federal government. `J~aki~n gil together these examples put the Jn~oblem In sharp foeus-onr estate tax laws are woefully out of date and need ~ç be revised. Dealing with this problem is the purpose of these heartags, ahd ~e should expect, Mr. Chairman, that the prepondergnce of evidence placed before this Committee will result In a tax reform bill going to the HouSe of ~epren~n I~'/d t~oryect Inheritance tax inequities. I peed not remind the member of this committee that the failure to enact changes in our*~~inheri~tance tax laws will place the future of family farm opera-, tions In jeopardy Our family farms have long been considered the heart of America's free enterprise system, symbolizing the best ~f our heritage and In- dependence. They piust be preserved if America's agriculture is gotng to continue to carry out Its vital role of producing food and fiber fOr our needs as well as the needs of others beyond our shores, Revising the estate tax laws so that the farms can be passed on from generation to generation without an oppressive tax burden appears to me to be the least we can do I trust this Committee will agree Before I conclude my remarks, Mr. Chairman, It behooves me, as a Repre- sentative from Nebraska, to recognize a farm wife from my state who has done as much or more than any one individual to call attention to the Inequities in our estate tax laws. She is Mrs. Doris Royal of Sarpy County, Nebraska. When our estate tax laws are changed, she will deserve a share of the credit. i am sure that membOrs of this coithilittee, and my ccllea~u~*ho are active in this area Of tax reform, know about Mrs. RoyaL An grticle reporting on her efforts appeared in th9 Septen~ber, 1975, Farm Journal under *the title, `Lets t~iet Rid of the Widow s Tax She was featured in a fropt page articlo in the Sunday New York Times for February 15 nuder the headline "Death Taxes Compelling Heirs to Sell Farm Land." PAGENO="0698" 684 I am grateful to Mrs. Royal for all she and her close associates have done to bring this problem to the forefront and generate needed support for changes. Thank you for this opportunity to appear in behalf of estate tax reform in general and the adoption of my own bill, H.R. 4808, in particular. Mr. BURLESON. The next witnesses compose a panel: Committee on Federal Taxation of the Chicago Bar Association: Hugo J. Melvoin, chairman. American College of Probate Counsel: William P. Cantwefl, president. William A. Sutherland, Esquire, Washington, D.C. Edward McGinty, Esquire, Tampa, Fla. Prof. Gerald P. Moran, University of Toledo, School of Law. Prof. Joseph M. Dodge II, University of Detroit, College of Law. Mr. CON~BLE. Mr. Chairman. I would like to welcome Bill Cantwell. I haven't seen him for many years. He used to be a very close family friend. I am delighted to see him before us. Mr. BURLESON. Gentlemen, we are pleased to have you. Will you begin, Mr. Melvoin. PANEL CONSISTING OP HUGO J. MELVOIN, CHAIRMAN, COMMIT- TEE ON FEDERAL TAXATION OP THE CHICAGO BAR ASSOCIA- TION; WILLIAM P. CANTWELL, PRESIDENT, A1VJ~ERICAN COLLEGE OP PROBATE COUNSEL; WILLIAM A. SUTHERLAND, ESQ., WASH- INGTON,. D.C.; EDWARD McGINTY, ESQ., TAMPA, PLA.; PROP. GERALD?. MORAN, UNIVERSITY OP TOLEDO, COLLEGE OP LAW; AND JOSEPH M. DODGE II, UNIVERSITY OF DETROIT, SCHOOL OP LAW Mr. MELvOIN. Thank you, Mr. Chairman. I appreciate this opportunity to appear before your committee and ask permission to reproduce the statement we have furnished for that purpose. Mr. BURLESON. Without objection, your full statement will be in- chided in the record. You may summarize. STATEMENT OF HUGO J. VIELVOIN Mr. MELVOIN. I would like to begin by noting thatI appear solely on behalf of the Committee on Federal Taxation, shice th~ Chicago Bar Association itself has not yet taken an official position on these matters. I have the pleasant job today of representing a group with no ax to grind. We are here to discuss a few general principles. This is appro- priate, because you are now at the stage of considering whether any changes are needed in this area; and our concern cuts across all of the major suggestions heretofore proposed to your committee. We believe it is important that lawyers who practice in this area should work with your committee to improve the estate and gift tax provisions of the code. I would like to emphasize that the committee I represent feels keenly that there is and should be an overarching concern in the area of esthte and gift taxation for simplicity and stability and certainty,,and that this concern is uniquely significant when you are considering any of the major proposals that have been presented over the last few years. PAGENO="0699" 685 As our paper reflects, we are talking primarily about those proposals that suggest imposing a tax on unrealized appreciation at death, a tax on generation skipping, the proposed unification of estate and gift tax, and the proposed unlimited marital deduction. We have analyzed these problems based on the premise given to us that gross revenues are not to be reduced, so that, as we understand the posture of your current review, if you increase the exemption `and thereby reduce taxes from that source, you are going to have to make it up somewhere else. Our concern is that some theory of increased equity, however worthy it may appear, nevertheless, may no't\be appropriate to adopt. The in- troduction of unreasonable complexity in the estate and gift tax area creates dislocation precisely at a time ~when people, who are thinking of death, want certainty above all and want to know what the cost of dying will be. We believe these considerations may well lead your committee to conclude that it is inappropriate to adopt that kind of legislation. That is why our committee does not attempt to list all the reasons you might use in support of or in opposition to any of the proposals. We have simply tried to identify those reasons which lend themselves to evaluation in terms of the need for simplicity, the need for stability, and the need for certainty. We recognize that cOmplexity is a relative matter. In income tax matters, you may well conclude that complexity is an appropriate cost to bear in attempting to eliminate some tax shelter abuses, as you see them. Our committee has, in fact, only finish~d reviewing recently the complicated provisions of House Report 10612. But we say that there should be a distinction drawn in that situation, because a man who is contemplating a significant investment in a tax shelter knows that there are tax problems involved and that he should hire `a tax expert t~ assist him. Compare the estate and gift t~x area. What concerns us is that in our experience we see that most of the wills and trusts are drawn by general practitioners; that the tax matters seem `to come up in context with family planning; and that perhaps neither the taxjayer nor his adviser will be aware of some new tax minimization trap that might inadvertently be created by the Congre~s. Put in simplest terms, if the cure is complex `and not well known to the general practitioner, legiti- mate family planning may `suffer. Our concern is that in your effort to improve the system, you should not thro'w the baby out with the. bath water. " . . I would like to give a few `specific illustrations, first by referring to ~ where you are dealing with the use of a trust, a ~7tT*fti~Irrëi31isiderand my committee considers to be perhapé the single most effective estate piannin~ tool we ha~re' in the entire estate planning tool box. . Our, experience has taught us that the need for a trust seems ap-. parent whenever it is `appropriate to ~eparateadministrati6n and in~ vestment of assets from the beneficial enjo~rment of those assets. Yeai~s ago it was dommon' to talk about a trust as though trusts ~veie in- tended only `~Or extremely wealthy people. We have learned that the need for trusts has ~always be~n there and that the~people whO should' use trusts ought to inálude people whose estates are ~elatively small. As pointed out earlier this morning, it is not unusual today to find PAGENO="0700" 686 that an individual of "modest" means has an estate of several hundred thousand dollars. The family home that cost $12,000 to $15,000 may now be worth $60,000 or more. The corporate employee whose group policy was $10,000 now has $50,000 or $75,000 or $100,000. The result is that he may have an estate of several hundred thousand dollars; that he must become concerned about the impact of death taxes; and that to carry out his estate plan he may well need a trust. As our formal paper states, we recognize that in one type of situation a trust may be utilized as a tax minimization device; and in another situation the trust form might be utilized solely because it is needed to meet the disability of a beneficiary or to handle a changing circum- stance. In fact, the very flexibility that makes the use of trusts so attractive in resolving family problems makes it difficult to catalog their variety. Now, if you are considering adopting legi~lation that is going to continue to permit the use of one form of trust that you con- sider appropriate, how can you do that and then capture and impose a special price tag on another kind of trust that you now think is no longer appropriate to go untaxed, without creating an extremely com- plicated system? That is what we have seen in all three of the proposals we have studied; they are the proposals introduced by the Treasury Studies in 1969, the American Law Institute report in 1968, and the American Bankers Association report in 1972 and again this year. I want to share with you the trust drafting experience of the lawyers' with whom I work in Chicago, and I come from a large firm and have' spent almost a quarter of a century in this work and have in that time probably drawn several thousand trust agreements. There has been a concern expressed that trusts may permit property to avoid death taxation for 100 years or more. That is a possibility. But, in our experi- ence, we have never drawn such a trust. William Sutter, himself a Chicago lawyer with a large firm, came in here 3 years ago and said he had heard of exactly one. To the best of my knowledge, the oldest trust in our office is less than 50 years old; and I believe Richard Covey stated when visiting your committee some time back that the statistics indicate that the average length of a trust is only around twenty years. If you are considering a solution that would capture legitimate family planning arrangements in its web in the process of preventing \ the abuse of one or two extended term trusts, our committee is deeply concerned that the impact is excessive and that the cost to the corn- Lmunity is too great. You shouldn't frustrate such family planning. Turning to the second major topic, I would like to further illustrate for a moment, if I may, what our committee has sought to do in auply- ing the principle of simplicity and certainty in connection with the proposals relating to imposition of a tax on unrealized appreciation at death. First, the recordkeeping problem seems to be significant in all three of the proposals. Further, if you want to tax anpreciation at death, von obviously have increased the family's liauidity problem: and the Treasury proposal, being an income tax. may have an unintended effect in the situation where the decedent dies domiciled in a State that imposes a State income tax that is correlated with the Federal income tax. PAGENO="0701" 687 Second, we are very much concerned about changing the basis rules. The present system is simple and understandable. You know that basis is the fair market.value at the date of death Or the value at the alternate valuation date. However, any of the "carryover" system concepts necessarily requires establishing a new basis for assets, which may not be able to be ascertained within a reasonable period after the death of the decedent. That is going to create problems for the executor, who already has his hands full. We see the recordkeeping problem in our work today. It will infest any system tbM requires you to find data that runs back for a long period of time, such as when we are tracing the decedent's contributions in connection with jointly held property, which, as you know, is includable in the estate only to the extent that the decedent made con- tributions. We find irvery difficult to get that kind of data. I think you will find that problem in all the proposals that are under consideration. The carryover basis proposal' has a further problem that will arise when trying to divide assets fairly within the family in the typical situation where the parent wanted. to give equal assets to both chil- dren. Each child may receive an asset having an equivalent fair market value today and `the executor may think `his jOb is done, but it isn't, because one child's asset may have a high basis and the other a low basis; and when the second asset is sold, that sale is going to generate a large gain, so that the child getting the asset with a low' basis is getting a tiirte bomb. Since time is short, I will out illustrate the two other major proposals analysed in our formal paper. Let me simply close with this observa- tion, if I may, I heard th'is morning a great deal of discussion relating to the family farm and `the small business; and since we come from Illinois where farmland in the central part of our State is now being sold for $1,000, $2,000 or, more per acre, I would like to indicate in one example something of the dilemma yo'ttr committee may face if you should take away a tax here and add a tax there without adequate regard for the interrelation of ~uch activity and the need for continued stability of the existing system. If you conclude, as some have sug- gested, that the $604000 exemption should be increased, that is obviously simple, and we could support the change on that premise. But increas- ing the exemption to $200,000 would cause you ,to lose, according to the Library of Congress, about half the revenue presently generated by the estate tax. If you have to make this loss up from some other source, you might conciude~to impose a tax on appreciation at death, but then I think you might'find that `an anomaly has occurred, you may have protected the family farmer or small business by increasing his exemption~ and then turned, around and socked him with an even higher tax, because the family farm is just the kind of asset that h'as gone up in value. If you will go one step further and imagine the aging farmer coming to his lawyer for advice, the lawyer might today say~ "I understand that you want to take care of your surviving spouse if she outlives you, that your son is capable of admnnsterizig the farm, and that you would like to pass the farm on to your gr~ndchildren when your son dies. Under current law, it would seem appropriate to set `up a trust. Your son could be the trustee and could manage the farm and pay the PAGENO="0702" 688 income to your wife, if she outlives you. When she dies, the son could begin to receive the income from the farm for himself during his life, and, when the son dies, the farm can then go to your grandchildren. And by the way, that seems to be an appropriate tax minimization plan to reduce future family liquidity problems. Although there will be a death tax when you, the grandfather, dies, there will not be a tax when your surviving wife dies nor when your son dies." The ultimate question for your committee is whether that trust should give rise to a special tax, because it is a loophole, which is simply a label to be attached to a technique no `onger approved, or whether such a trust should be recognized as an effective family planning tool and allowed to be continued to be used without imposition of any such special price tag. Thank you, Mr. Chairman. [The prepared statement follows:] STATEMENT OF Huoo J~ MELv01N, CHAIRMAN, COMMITTEE ON FEDERAL TAXATION OF THE CHICAGO BAR ASSOCIATION The following comments are submitted on behalf of the Federal Taxation Committee of the Chicago Bar Association concerning certain major proposals presently being considered by the Committee on Ways and Means., (The Chicago Bar 4~ssociation has not yet taken an official position on these matters.) As may be anticipated when dealing with a large group of lawyers, we dis- agree sharply within our Committee on political philosophies. Nevertheless, we believe we can be of help to the Congress because our collective experience enables us to provide practical reasons why certain solutions appear either ap- propriate or unworkable to a given proposal, regardless of how many of our members approve or oppose the merits of the proposal itself. In the course of our work in the field, we have counseled with hundreds of taxpayerS as they determined whether a gift should be made outright or in trust; whether and at what times assets should be distributed to a beneficiary; and whether and to what extent some family member or advisor should be given control over the disposition of those assets in his capacity as a trustee or as the clonee of a power of appointment. When death occurs, we know first-hand the job of obtaining Information from families of decedents, some of whom were meticulous record keepers and others who were not. We have seen the actual problems that have arisen as we have consulted with families when cash was needed to meet death taxes, where the assets that gave rise to those taxes were tied up in the family business. We have learned something of the large amount of time that is required to educate lawyers about new tax legislation, notably in 1954, 1962 and again in 194E~9. We know that many wills and trusts probably the vast majority of these instruments, are not drawn up by tax experts, but, rather, by general practitioners, lawyers who know the common law Well enough, but whose knowledge of the tax law relates pri- marily to those general provisions which have been part of the estate and gift tax law for 40 years or more. Out of the body of our Individual experience has come adherepce to the shared principle we urge upon your Committee today. That unifying principle is the need for stability, simplicity and certainty in the creation of any new legisla- tion In the area of estate and gift taxation. I am here today on behalf of several hundred lawyers primarily and essentially tO emphasize the overarching im- portance of these factors in this area of tax law. In our judgment, even an admitted improvement may not be sufficient to war- rant a change achievable only by adoption of complex law. Complexity generally means uncertainty; and uncertainty means not only difficulty of administration for the Government, but diffiulty in achieving understanding and certainty in planning wills and trusts for the thousands, perhaps millions, of people whose greatest desire is to be sure they know who will inherit their estates and at what cost. Complexity is admittedly a relative factor in evaluating a new tax law. Your Committee may believe that complexity should not be a strong adverse factor when you are considering certain proposed changes in the Income tax area PAGENO="0703" 689 which appear to affect only those taxpayers who can aft~ord to engage tax experts to help them navigate through any new cross current you may intro- duce into the Internal Revenue Code. In our experience, we would agree that a taxpayer who is considering a significant tax-sheltered investment likely will hire a tax expert. But, we would emphasise, this is precisely because that tax- payer knows be has serious tax Issues to consider. Compare the case involved in the drafting of a will or a trust, however, where the typical client most likely will be dealing with a general practitioner and neither lawyer nor client will be aware of a sophisticated tax trap, particularly in the thottsands of situations where the drawing of the instrument is not motivated by tax mini- mization considerations. To cite one example, more than 5 years have passed since the Revenue Act of 1969, but we still see new wills being drawn giving a life estate to the spouse and the remainder to charity. We know your Committee is already aware of this lingering problem, since you reported out only two weeks ago HR. 9889, to extend the time within which to cure documents affected by this 1969 change in the law. This leads our Committee to emphasize to you that revision of In- struments is a slow process and, for that reason, to urge that ample time be given to enable lawyers to become familiar with any changes and to advise their clients what to put in their wills and trusts. If simplicity is needed to help lawyers who are not tax experts understand the new law, simplicity is also needed to help the taxpayer understand the alter- natives that are available. Effective communication with our clients is a major part of our work. Some may tartly suggest that a taxpayer intelligent enough to seek our advice needs nothing more. Sadly for our egos, we have seen it hap- pen that a client confronted with too much complexity may throw in the sponge and select a simpler, but patently inferior, alternative. For example, if the use of a trust appears apprôpriate--and trusts may appear approprite whenever a family situation Indicates the desirability of separating management of assets from their beneficial enjoyment-we urge your Committee not to adopt a change that will lead a general practitioner to hesitate in suggesting the use of a trust because the tax consequence have then gobe beyond the comprehension of the lawyer or his client. To this concern we reserve our most urgent caution: In our view, the Congress cannot afford to disrupt existing patterns of wills and trusts unless there is sub- stantial agreement that the changes sought will represent an essential and major improvement in the tax system. Accordingly, turning to our specific comments, we ask your Committee to keep this principle in mind while you are still at the stage of determining whether to favor any tax on unrealized appreciation at death, or to tax generation skipping transfers, or to expand the marital deduction, to cite just three of the major proposals discussed in the American Law Institute Report (j968), the Treasury Studies (196i~) and American Bankers Association Commentary (1972 and 19T6). We have sought neither to favor nor oppose these proposals, nor have we sought to list all the reasons ~our Committee might use to support or reject any of them. Rather, we have purposely restricted our comments in order most effectively to highlight those relevant to the application of the tests of simplicity, certainty and stability. 1. UNIiEALIZED APPEECTATIO~ AT DEATh; BASIS We first note that both the "capital gains at death" and "carry-over basis" pro- posals have significant disadvantages: (1) Under both proposals, record keeping (~artlcularly the decedent's histor- ical cost records) would always be an a~1ministrative headache and could easily become a major source of dispute in practice. (Proof of the gravity of this prob- lem Is already too much with us. Difficulties arise in tracing a decedent's con- tributions whenever we have the job of determining the extent `to which joint propertyshould be taxed at death.) (2) Under both proposals, failure to provide a "start up" date would be criti- cized as unfair, yet to create one would require a national appraisal date, 1n~ volving an enormous number qf appraisals, imposed at large cost and without any guarantee of adequate retention even of those records in the future. Under the capital gains at death proposal, there is the additional complexity stemming from the fact that interrelated computatiOns will be required to deter- mine the amount of tax arising at death (federal estate and federal income tax). Your Committee may also be concerned that the resulting estate tax deduction for the tax paid is regressive in effect, imposing tax at higher effective rates on PAGENO="0704" 690 small estates than on large ones; and your Committee should be aware of the ef- fect that an income tax at death will have under those State income tax systems which are coordinated with the Federal tax system. Under the carry-over basis proposal, there are the further complications of basis allocation, namely, determining the appropriate method by which the carry- over basis should be increased for death taxes paid and then determining how such increased basis should be allocated among the assets of the dOcedent, some of which go to make up a marital or charitable gift. In all taxable estates there will be a delay In knowing the basis of particular assets until the computations are finally approved; this delay will impede sales from being made promptly after the decedent's death and will thereby add to the administrative costs of executors. Further, any differential in basis between assets having equal fair market value will render difilcult the distribution of assets within the family. Finally, to the extent post-death sales are required to meet liquidity needs, such sales will in turn generate further Income tax, making the carry~over basis proposal more like the capital gains at death proposal. We note that the alternative reluctantly suggested by the American Bankers Association provides for taxing unrealized appreciation without as much com- plexity as the other proposals we have studied. Keeping in mind that the ABA favors retention of the present system and that their "Additional Estate Tax" technique is complicated by the record-keeping requirement already described, at least the "AEP" tax is computed without undue complication and the proposal does not disturb the stability of the existing basis system. 2. GENERATION SKIPPING The members of our Committee encounter in our daily practice a wide variety of family needs and goals wholly unrelated to tax minimization. The frequency with which we turn to the use of some form of trust to solve those problems has long since demonstrated that the trust Is probably the single most effective legal tool we have in our estate planning tool box. We also draw trust that combine family goals with tax minimization, most commonly the type of trust that pays income to the surviving spouse for life and then distributes the assets to the chil- dren, free of estate tax at the death of the surviving spouse. Our concern Is that the Congress might inadvertently throw the baby out with the bath water. Knowing that some trusts do involve tax minimization goals, we nevertheless urge your Committee not to adopt any legislative solution, worthy as it may appear in theory, if you believe the solution, by its Inherent complexity, will have the effect of discouraging the general use of trusts in estate planning. If Our Committee proceeds to draft a group of new Code sections under which tax is imposed upon some generation skipping transfers, we can only urge that those provisions relating to excluded transfers, the time of imposition of tax and the identity `of the taxpayer or taxpayers upon whom the tax is imposed be crafted with caution so that they will not discourage the use of trusts as legiti- mate instruments of family `financial planning. We have studied the efforts of the American Law Institute, the Treasury De- partment and the American Bankers Association to create a workable system of taxing generation skipping transfers. Respect is owed each of these proposals for their considerable ingenuity; but all of these proposals demonstrate ~uch a high degree of complexity that even lawyers experienced in dealing with the In- ternal Revenue Code have found them particularly difficult to analyze and com- prehend. If those regularly engaged in tax work find it difficult to comprehend these proposals, is It reasonable to expect that a general practitioner confidently will be able to advise clients as to the operation and effect of such proposals within the foreseeable future? 3. MARITAL DEDUCTION Both the American Law Institute (1008) and the Treasury Studies (1909) proposed an unlimited marital deduction. The American Bankers Association later proposed an intermediate idea, under which the marital gift could be the greater of the present limit of 50 percent of the adjusted gross estate or $250,000.00. We note that increasing the marital deduction may lead to substantial revi- sion of existing documents, but should simplify administration of estate tax collections, since there will be fewer taxable estates to audit; and that t'he plan- ning and administration of certain estates will be made simpler, to the extent ~taxpayers conclude to abandon the complexity of existing marital formula gifts in favor of transferring the entire estate to. the surviving spouse. PAGENO="0705" 691 If there is a caution to be noted, It is in the fact that an `Increased or unlimited deduction, because of the attraction of immediate tax savings, may subject the estate of the survivor to a greater tqtal tax than under the present sysem. rrhe liquidity crisis may be postponed, but b3r postpOttement the taxpayer may make it worse. This may re~i~lt in unexpected burdens on surviving children and others. 4. UNIFICATION or E5TA~E AND GX1?T TA~ATION In our experience, few taxpayers makesignificarit lifetime gifts, even after they have been advised that such gifts may avoid estate taxation. The perceived horror of becoming dependent In old age is a powerful deterrent. The proposals relating to "grossing-up" taxable gifts and gift taxes paid would add complexity to the present sVstem and. discourage llfötlme transfers. Accord- ingly, it would seem that such a proposal should be adopted only if your Com- mittee concludes it is appropriate to accept the dampening effect this will have upon your present policy of encouraging lifetime gifts. The proposal to make gifts "easy to complete" adds complexity and new un- certainties without that type of readily perceived essential benefit that warrants doing away with the existing system of gift taxation and likely would do little to encourage lifetime giving. If your Committee should Conclude that some form ~f unification of estate and gift taxation is desirable, our concern for similicity leads us to recommend adop- tion of a "stacking" method similar to that suggested by Senator Nelson. This would have the virtue of retaining the existing' separate gift and estate ta~ systems, with which we are familiar, and then, for the purpose of computing the federal estate tax, adding the value of taxable gifts made during lifetime to the gross estate. CONc~U5TON We have for many years sought to aid the Congress in the evaluation of pro- posed tax legislation by means of detailed comments on the specific language of bills reported out by your Committee. Currently, we have also studied a number of matters that warrant your consideration at a later date, following your evalua- tion of major reform proposals. Our dominant concern tod~ty for the need to retain simplicity and certainty in any bill that may emerge requires that our initial comments be made in gen~ eral terms. However, we want exp]icity to confirm our desfre and willingness to provide detailed comments as the occasion may arise In the future. Mr. BURnISON. We will take the witnesses in order. Mr. Cantwell is next. STAT~]~1~ENT 0F WILLIAM P. CANTW~LL Mr. CANTWELL. My name is William Cantwell, and I am the `presi- dent of the American College of Probate Counsel. The organization is a group of 1,700 probate specialists from every State in the United States, and while I perhaps have an ax that I am carr.ying, I do not believe that it is well-honed, and I am not here for the purpose of applying it. Our presence before you now is not to enter directly into the fray insofar as favoring or disfavoring any of the many proposals that' have been placed before you, but to offer the services of our organiza- tion, with representation in each State', to advise your staff as to how any particular proposal would work within the probate system. It seems an obvious truth to state that within a period from today into the early part of the' next century, all American wealth that is capable of' being transmitted will, in one way or another, pass through the probate system: Our consistent concern has been that the probate system be one in which the tran~mission of wealth could occur in an orderly, expeditious, and if you will have it, a reasonably priced, mechanism. We find, as representatives of the clientele subjected to 68-872-76-------45 PAGENO="0706" 692 that system, that the estate and inheritance tax transactions through which probate property must pass tend persistently to dominate he working of that system and, as well, to dominate the form of disposi- tion of property~ We are here to suggest to you three basic things. Those three things are stability, neutrality, and the rights of the probate taxpayer. By stability I would like to associate myself with all of those com- ments that Mr. Melvoin made regarding the existing structure for the disposition of wealth in this country. I don't believe there is anything like an accurate count of the number of plans for estates in this coun- try, but I have already suggested that all American wealth, one way or another, must pass through some form of probate or estate planning procedure. I would at least venture that there are outstanding some 20 million American estate plans. I believe they have been developed with a consistent respect for the state of the law since the Revenue Act of 1948, and that any radical change in the legal procedures by which those plans would dispose of wealth would place an impossible burden on the taxpayers and an absolutely unmanageable burden on the pro- fessionals expected to deal with amending those plans. I therefore would suggest, and urge, that as far as our group is concerned, dealing intimately and specializing on a day-to-day basis with the transactions through which these persons must dispose of their wealth, that the matter of the stability of the law is indeed an objective of a very high order, and that any sweeping substantive changes in the law without a very long lead time would place American taxpayers at a material disadvantage and could be totally counterproductive to whatever may be the objectives of estate and gift tax reform. It could end up as re- form benefiting the professionals while exacting funds and frustration from the public and the treasury. My second point is neutrality, I too live in an agricultural State, and I find it difficult to disassociate myself from the thought that there should be special legislation for special classes of taxpayers such as farmers and ranchers. I don't believe that there is any problem that I personally deal with that gives me more trouble than the problem of liquidity for agricultural enterprises, and yet I deal with that., and in the planning phase with my clients, I suggest in advance that they too (teal with that. I think that all of the history of tax legislation which has attempted to single out particular classes of taxpayers for par- ticular types of treatment has, in turn, ultimately become counter- productive tax legislation, for in attracting wealth into a particular form of activity because of potential tax advantages, I believe it tends to distort the economy. I believe some of the very problems we deal with here this morning with respect to agricultural enterprises have themselves perhaps been created by the attractiveness of agriculture as a form of investment for tax benefits. And therefore, while I person- ally would feel that the problems of the agricultural enterprise and any other small business enterprise ought properly to be dealt with, I would hope that they could be dealt with in a totally neutral form so that the tax laws neither force nor encourage any particular form of business enterprise or business activity simply because. of the structure of those laws. And that is the meaning of my thought with respect to neutrality. PAGENO="0707" 693 With respect to the matter of stability, why are we here concerned with estate and gift tax reform? Concededly there may be some in- equities, and perhaps the agricultural problem is an inequity. How- ever, I would suggest to you that through borro~ving devices, through postponement devices, through expansion of 6161 and 6166, that that problem could probably be dealt with well. It could be aided by new valuation techniques which are different from those applied today. As to other inequities, I do not find in my practice that the adminis- trative difficulties in administering a tax we have lived with for a long period of time are themselves unlivable. I am certainly disturbed, and I would hope that perhaps there is reform required in the matter of noncompliance in gift tax filing and meeting gift tax obligations. I am concerned that the original objectives of the 1948 act have not been satisfactorily achieved, and that perhaps reform is necessary to accomplish this, But these conceded yet minimal areas need to be placed on a scale of values opposite my position urging stability in the disposition of the affairs of American taxpayers representing the results of a thrifty lifetime. To me the scale tips very, very heavily against any broad brush changes which would require revision of millions of estate plans, possibly accompanied by non-revenue-produc- ing complexities of a sort which the legal profession is not equipped to meet. Our particular clients, our probate ~iients, are clients w1~o are examples of the classic thrift and self-support concept of the American economy. We believe that they, certainly as much as any special class of taxpayers, have a series of rights. In my prepared paper I have suggested to you a series of areas in which we believe our probate clients do have rights and substantial concerns. As a first in this series of questions, we are concerned that any reform your committee might propose to the Congress should address problems of the relationship between your tax and the State inheritance tax. This question extends to the necessity for filing two tax returns, often on an inconsistent basis, which can subject taxpayers to a whip- sawing relationship between the two taxing entities involved. We are next particularly concerned with the overall valuation prob- 1cm. We would suggest to you that the valuation technique used on agricultural and other real estate, as well as closely held businesses, could stand great attention from this committee, and ~inight in itself go a very long way to take care of the agricultural and other small business concerns with. which you are dealing. Valuation is really the genesis of the problem, and liquidity required by valuations which are vastly inflated because of forces beyond the control of the taxpayers appear at the h~art of the nature of the agricultural and the small business problem. Another of our concerns would arise if this committee. should pro- pose a unified tax. Where wOuld taxpayers stand with respect to the basis problems and the horrendous administrative difficulties created by any form of carryover basis? We are equally concerned that if a unified tax should be enacted that the existing noncompliance with the gift tax statute would be accentuated. Picture, for example, the dif- ficulties that would ensue in attempting to make a lifetime catalog of a giving program in order to do justice under a unified tax. In another ayea we. are hopeful that if there should be reform, that the~ extrernely~ djfficult prpblems of joint tenancy tracing migl~t, in PAGENO="0708" 694 some manner or another, be erased from the law by simply allowing joint tenancy to be taxed on an objective `basis. We are very deeply concerned with noncompliance with the existmg gift tax statutes overall, in the joint tenancy area, and in other areas as well. There simply exists no objective technique, such as the with- holding tax, to deal with joint tenancy under the existing statute, and we think a bill' of rights for taxpayers, for our type of taxpayers, should protect the filing taxpayer, the compliant taxpayer, from the reduction of revenue from the noncompliant taxpayer, particularly in the gift tax area where there doesn't seem to be any particularly good policing mechanism. We would suggest that any legislation that might come forward would be legislation aimed at an ease of compliance rather than a. com- plexity of compliance. We would hope eventually that the Federal Government and the State governments might seek a method by which a single return rather than a two-return system could operate. We would hope that the liquidity problems might be dealt with by a much more objective workout of sections 6166 and 6161 so that the administrative intervention of enforcement personnel does not prevent the intent of those statutes. On an ultimate basis then, what our organization, concerned with the probate clients of this country, would seek would be a recognition that, just as in 1948 there was a series of abuses by virtue of the dif- ference between community and common law States, that now there is a series of problems that need to be dealt with. The 1976 problem's seem to center around the question of inflation, the interrelated question of liquidity based on inflation, and the objective of maintaining the potential for the small enterprise. We would think that the time has arrived for some form of taxpayers' bill-of -rights- a new version of the Revenue Act of 1948 to redress current inequities as that act was' aimed at the 1948 problems. The 1976 statute would seek to deal with the inflation, liquidity, and small business enterprise obiectives. We would hone that any legislation might carry out the thoughts that I have tried to suggest to you. First, that there be neutrality-in other words, that the tax statutes not dictate any more than is abso- lutelv essential the form of a family transaction., Second, that you seek stability. That would regard as significant the tremendous iflvestment of time, energy and personal anguish involved in those 20 million wills that are `sitting waiting to be probated in lawyers' offices, and that you consider simplicity as an ultimate objective. More and more, com- plexity for taxpayers is becoming a factor in their attitude toward the working of their Government. We seek help in making the probate procedure an expeditious procedure and not a procedure in which delays and difficulties are based on the Federal tax system rather than on the local probate system, or on the delinquency of individual law- yers, which we are as opposed to as anyone. Our offer to you is that we would like to help you determine how, in a probate sense, any proposals you ultimately adopt would work, and we offer our services for that purpose. I have a written statement, and I would ask that it be entered into the record, and I appreciate very much the opportunity to testify. PAGENO="0709" 695 Mr. BrRLi~so~. Without objectioti, your full staternetit will be in~. cluded in the record. Thank you, Mr. CautweIl. [Mr. Cautwell submitted the following:] AMERICAN COLLR~R or PrO~Ari ~o~; Lo~ Angete~, Calif., !iJ~a~-ch 1f~, 1976. JOHN M. MARTIy, Jr., Esq., Chief Counsel, Committee on Ways and Means~ t7.A~. 1Iou~e of Rcpreaestatft'es, Longworth House Office ~uilding, Was1iihgt~~i, D.C. flEAR Mn. MAIrrII~: This letter follows up on the telegr~pbi~ request that a representative be permitted to appear before your Cominitte~ on behalf of the American College of Probate Counsel in accordance with the press release Febru- ary 20, 1976. This will supplement that request to be heard. a~id supply the information requested by the press release, 1. Capacity in which I will appea'r William P. Cantwell, 2900 First of Denver Plaza, 6S~ 17th street, Denver, Colorado 80202, (303) 89~-290O. I will appear as President o~ the American College of Probate Counsel, an organization described iii the supplementary materials attached to this letter. 2. Representation I will represent the American Coli~ge of PrObate Counsel, whose address is 109~4 West Pico Boulevard, Los Angeles, California 90064~ (21a) 475-4200. Attached as Exhibit A is a statement of the Object of the American College of Probate Counsel, a Forward written by me, which Is a part of the Roster of the College, a list of the Members Emeritus, who are Past President of the organi- zation, a list of the State Chairmen for the 11Yt5-4970 bn~hiess year of ACPC, and a list of the 13oard of Regents for the 1976-1976 buslnE~ts year and a list of the American College of Probate Counsel Honorary Fellows. ~ou will note that among the Honorary Fellows of the College are three Supreme Court Justices. The membership of the College exceeds 1700 estate planning and estate admin- istration specialists, organized on a nationwide basis, which will be described below. 3. Conflicts of interest I will be making a statement on behalf of the American College of Probate Cottnsel. I am a member of the law firm of Dawson, Nagel, Sherman & Howard of Denver, Colorado, but to my knowledge neither I for nib' law firm has specific clients who have an Interest in the subject, other than the interest of all citizens seeking a sound tax system, and I am not representing any client having an interest In the subject which I will be discussing. 4. Provisio'ns of the estate and gift taa' laws on which I will testify My testimony will be aimed at overall estate and gift tax reform In the sense that I do not at this time propose to discuss specific tax reform proposals that have been considered by past Congresses, My objective in discussing estate and gift tax reform is to bring to the Committee a new perspective, one which will be directed toward what, in the opinion of Estate and Gift Tax Eeform Commit- tee of thO American College of Probate Coun~el, is inueh-xie~ed reform. In this connection, however, on behalf of the American College of t~robate Counsel, I request that the record may be held open so that if the hearings during the week of March 15 through March 19 dIsclose specific proposals which we of the American College of Probate Counsel believe require discussion, we wish an opportunity to submit for the record an analysis or reaction to some of the proposals, This presentation to you, however, is x~iade in the lig1~it of the special nature of our organization. Attached as Exhibit~ 13 to this analysis is a July 1973 analysis, "state Inheritance or Estate Taxation of Non-Resident Estates" com- piled by ti. Bradley Jopes, Lo~ Angeles, California, a Fellow of the American College of Probate Counsel, with the assistance of the 50 stpte representatjves t1~roughout th~ United States. In connection with the questlon of estate and gift tpx reform, one of the basic Issues is the Integration or re'ationship between state Inheritance or estate taxation and federal estate and gift taxation. Essentially, we are learning from througl~out the country that the lawyers in the several states are finding that many consumers~ man~' beneficiaries of estates, PAGENO="0710" 696 and many fiduciaries are complaining that the probate process and the delays Of probate and the costs of probate arise not out of antiquated systems of probate about which much has been heard but rather from the administrative problems caused by the federal estate and gift tax, and the administrative problems caused iby state inheritance or estate tax. There is much need for a closer intergovern- mental relationship and for leadership from the federal government to persuade ~.states tO alter their systems of death taxation to procedures which will, by a ~simple administrative means, tie into the federal estate tax so that estates do not have two separate, independent and often inconsistent tax returns, two separate tax audits, two separate tax determinations, and two separate crises with respect to the liquidity problems of estates. Attached as Exhibit C to this letter is a 1970 analysis by Fellow Richard H. Pershan of New York, "Applicability of United States Estate Tax and Gift Tax to Nonresident Aliens," again a subject which is the summary of studies that were made by the American College of Probate Counsel with respect to the practical types of problems that the probate practitioner is discovering throughout the country. In this case there was put together information for all of the 50 states so that those states would have a better idea of what were the' situs rules in estate tax conventions with respect to foreign governments. It is my opinion that the American College of Probate Counsel through its statewide resources and its expertise can be of assistance to the Congress in its deliberations in connection with estate and gift tax reform. As President of the American College of Probate Counsel, I am offering those resources. In connection With current consideration of estate and gift tax reform, it is not my position at this time to comment upon the social objectives of whether or not there should be a different incidence of tax and an accompanying shifting of wealth or changing tax burdens. However, we have numerous members of the College who are prepared to discuss such social objectives. Neither is it my objective in this particular presentation to discuss such things as the technical problems with a generation-skipping transfer tax or the technical problems with an additional estate tax on appreciation at death or the basis problem if in lieu of some taxation of appreciation at death there is a carryover basis. Again, I am not proposing in this paper to discus's such technical matters, although numerous members of the College have written extensively a~ lawyers representing com- mittees studying estate and gift tax reform for the American Bar Association or for their state and local bar associations. In other words, our members on a nationwide basis are prepared to submit to the Congress in a very short period of time an analysis of the nationwide impact on a state-by-state basis of any significant tax reform proposal that Congress receives or is seriously considering. My presentation today will be aimed at giving to Congress our perception of the thrust of the concerns of our clients who are the beneficiaries of estates' and who are the fiduciaries who must cope with the tax administration process, both federal and state. Thus, it will be my role to pose to the Congress some relatively basic questions which might best be wrapped up in the concept that it is the belief of our Estate and Gift Tax Reform Committee and of the President of the American College of Probate Counsel, based upon conversations with members and clients, that we have reached a point where there is need for a "Taxpayers Bill of Rights" In the field of estate and gift tax reform. Putting it another way, the American College of Probate Counsel has been one of the leaders in the development of the Uniform Probate Code which has sought to simplify probate procedures and to speed up probate settlement processes and to reduce the costs of the probate settlement process. Notwithstanding those efforts which are achiev- ing respectable success, a persistent obstacle to even more effective probate reform has been the federal estate and gift tax laws and the state inheritance and estate tax and gift tax laws. It is our hoie `that through th~e actions of Congress looking toward estate and gift tax reform that it will not only be possible to accomplish what may be the revenue objec~ves or other objectives of a sound federal estate and gift tax system but that the system will also accomplish a number of the other desirable attributes of a sound tax system. We include among these a contribution toward simplification of probate proce- dures, a contribution toward speeding up the probate process, a reduction of the cost of the probate process, and a contribution to the simplification and under- standing of the estate and gift tax laws as they apply to the citizens of the United States. A resort to the Socratic technique may be helpful and in that spirit, point up our concerns, I pose for the committee a series of questions: PAGENO="0711" 697 1. We presently have a eomrnlttee Of representatives of the 50 states of the United States working on a state-by-state basis preparing an analysis of the economic effect of the state death tax credit. That report will be ready within one month and will be submitted to the House Ways and Means Committee for its consideration in connection with its deliberations. One question that the authors of this report have posed is whether the Congress is willing to reconsider the questions relating to intergovernmental relations. For example, Is the federal government, having encouraged states to get Into the state death tax field, now prepared to consider abandoning the death tax field to the states (as has been clone recently In Canada) ahd aba~ndoning the gift tax (as has been done recently in Canada), or is the federal government willing to consider as a matter of policy some procedure which may Involve the federal government collecting the estate and gift taxes and then paying a subvention back to the states. If that alternative is not available then would a change in the federal credit to the states for the state death tax credit in such a way as to reduce the number of state death tax returns which must be filed be possible? At a minimum, it would be extremely helpful to encourage the states which presently have an inheritance tax requiring separate complicated calculations to shift to an estate tax In the nature of a "pickup" tax as a percentage of the federal estate tax whlëh' will then make for simplification of calculations of the tax and speed up the settlement of estates. 2. How can we simplify the valuation of assets in order to reduce the costs and delays inherent in valuation of assets and the disputes that traditionally arise in the asset valuation process? 3. How can we simplify the determination of the bases of assets if there IS going to be an additional estate tax at death or a carryover basis? 4. How can we simplify the taxation of jointly-held property or property held as a tenancy in the entireties in such a way as to eliminate the problems of trac- ing? Tracing can involve going back for many generations to determine whether the decedent or the survivor has contributed to the acquisition price of property held jointly at the time of death. 5. How can we avoid the serious problem of nonfiling in gift tax returns where people have made taxable gifts or reportable gifts over their lifetime and do not discover that they have gift tax obligations until they consult an attorney who advises them that what they have been doing over the years have constituted taxable gifts? 6. How can we solve the tracing problems in community property states to de- termine what is separate property and what is community property, or is there some way to reduce the problems of proof of title to property for purposes of calculation of death taxes? 7. How can enforcement of the estate and gift tax laws avoid uneven admin- istration of matters subjective in nature or not susceptible of accurate ascertain- ment, such as contemplation of death motives, ~a1uation of assets, contribution to jointly-held property? 8. How can we conveniently deal with contemplation of death so that we don't have the administrative and litigdtlve problems at the time of death? For ex- ample, could we at this time shift from the three~year presumption in IRC Sec- tIon 2035 to a two-year conthlslve presumption In which if a transfer has oc- curred within two years' of the date of death it will be Included in the estate of the decedent, and as some offset `to the possible adverse effect of that, how do we work out the exemption for small gifts, Christmas or otber*ise, prior to death, and what other adjustments should be made to the concept of contemplation of death gifts to achieve administrative simplicity? 9. How can we be more objective on the tracing of the acquisition of jointly- held properties so that the probate process and the settlement of the estate need not be delayed because of the existence of jointly-held properties which may not even be a part of the estate, even though the tracing and the dispute add to the cost of administration? 10. How can we avoid' the whipsawing problem between state and federal death tax agencies in which each agency refuSes to close its file or settle its case until the other has done so, and where each agency will take Its best shot at the estate or taxpayer but hold open the statute of limitations for the purpose of determining whether there can be a higher tax imposed because the other agency imposes a higher valuation with respect to a particular a~'set? 11. How can we reexamine and further the objectives of the 1948 Act adopt- ing the marital deduction which was aimed at equalizing community property states with common law states? PAGENO="0712" 698 12. How can normal, frequent, and persistent interspousal property transac- tions be effectively and permanently removed from the estate and gift tax area, particularly for the purpose of mere perfectly ~ecomp~ishing the purpose of the Revenue Act of 1948? 13. HoW can we reduce the number of tax returns which must be filed by es- tates of decedents? ~For example, what is the revenue effect and is It desirable to raise the minimum exception to $1.50,000 Cor an estate since the ravages of in- flation have caused a $150,000 estate to be less than the $60,000 exemption in terms of true dollars? 14. How can we solve the problems of d~eiinquent gift tax returns and the avoidance of the implications of tax fraud or penalties where there are in- nocent violations of the gift tax for filing requirements? 15. Why can't the reform of the estate and gift tax laws set up a law in which compliance is perfunctory, as income tax withholding statements are perfunc- tory, when someone gets a job and is paid a salary? 16. Why can't we turn the question of estate and gift tax reform into a ques- tion of probate reform aimed at benet1tt~ng the beneficiaries of estates who look to the system now as one which victimizes them because of the complexity and costs of determination? 17. If a unified ta~ is adopted, even more emphasis on proper reporting of inter vivos transfers will be required for even enforcement-what techniques for ob- jective and reliable reporting requirements will be present? i8. how can an "actual use by the decedent at death" concept of valuation be effectuated to avoid very heavy liquidity demands in estates with land having potential for other higher uses, b~it no historical basi~ for valuation for such higher uses? ID. Could not an "historical use" by a decedent or his ancestors over a long period of time be useful in difficult land valuatiQn matters? Beyond this series of questions, we believe there is one overriding considera- tion, central to the thought of a taxpayer's ~ill of rights I have suggested. We would hope that the estate and gift tax reform process would become an out- standing opportunity to give to the taxpayer as part of his bill of rights a free- dom from continually increasing administrative burdens. We do not honestly believe that attempts at theoretically perfect solutions to abstract and infre- quent problems or apparent abuses contribute to the objective we are discussing. In our view, the objective can best be attained if the Congress carefully defines its concepts and limits the proposed solutions t~ the minimum necessary to ac- complish its goals. It should avoid the imposition of a "national probate system" (and corresponding national drafting standard) through the tax system. Thus, in areas such as taxation of capital gains at death, generation-skipping, and the like, Congress could define its result and leave to the client and the practitioner maximum flexibility in planning the client's affairs (i.e., the tax differentials of various approaches should not be so severe as to force clients to adopt methods of disposition which are unnatural under the circumstances). The basic philosophy of such a taxpayer's bill gf rights would be to keep the estate and gift tax laws essentially neutral in order to avoid forcing one disposition or another through tax impact or drafting requirements. I have appreciated the opportunity to present these matters and I request the opportunity to present written replies or analyses to any questions which may be presented to me When I make my appearance Wednesday, March 17. Yours very truly, WILLIAM P. CANTWELL, President. Attachments. PAGENO="0713" THE AMERICAN COLLEGE OF PROBATE COUNSEL Object The object of theColiege Is to establish and maintain as an integrated group lawyers skilled and experienced In the preparation of wills and trusts and the probate ~and administration of the estates of decedents, minors and incompetent$ to improve and enhance the standards of probate p~~ctice, the adminl~stration of justice ançi the ethics Qf probate practice of the profession. To accomplish these aims, the purposes of this College shall be, among others: (a) To bring together members of the profession thus qualified and whO, bY reason of. their character, personality and ability, will ~ofltribute to the accomplish- ments, achievements and good fellowsh!2 of the College; and (b) To cooperate and consult with the various bar asscçlations ~f the several states and subdivisions and such Qther groups andorganlzatlons devoled to slm~lar attainments, Including governmental agencies. PAGENO="0714" 700 FOI~EWORD The Roster of the College Is a list of some seventeen hundred lawyers from every state and several foreign countries. Our charge to ourselves is to admit to fellowship outstanding probate practitioners who have demonstrated exceptional skill and ability. It would seem, then, that being a Fellow is itself a fc~rm of recognition of accomplishment and so most of us view it. Yet, on the opposite page you may read that the association of ourselves into this grouping is only the threshold of our objective, Being associated, we have an obligation. We have adopted as our polar star the object of improving our field of law, across the board. We do so in an honorable tradition, long Impressed upon me by these words of the great Elihu Root spokenin 1904: "He is a poor"spirited fellow who conceives that he has no duty but to his clients and sets before himself no object l~ut personal success. To be a iawyerworking for fees is not to be any the less a citizen whose unbought service is due to his community and his country with his best and constant effort And the lawyers profession demands of him something more than the ordinary public service of citizenship. He has a duty to the law. In the cause of peace and order and human * rights against all injustice and wrong, he Is the advocate of all men, present and to come." As another year ih College history opens, I hope each of our Fellows can respond to the demand for "somethIng more." The opportunities are legion, If we are truthfully persons of exceptional skill and ability, we fit into a natural alliance to improve the law in our field by seizing such opportunities. William P. Cantwell President PAGENO="0715" 701 MEMBERS EMERITUS [Past Presidents) JOHN S. CLO~K-1949-1953 Long BOach, California JOE B. HOUGTON.~..1953-1955 Tulsa. Oklahoma STEPHEN BRETHORST-1955-1957 Seattle Washington MILLER MANIER-1951-1958 Nashville, Tennessee R.V. NICHOLS-1958.1959 Fort Worth Texas LEON SCHAEFLER-195g.1961 New York New York J. LOUIS EBERLE-1961-1962 Boise, Idaho EUGENE GLENN-1962-1963 San Diego, California W. HARRY JACK-1963~1964 Dallas, Texas *DONALD M. MAWHINNEY-1964-1965 Syracuse, New York HARRY GERSHENSON-1965-196 St. Louis, Missouri JOSEPH TRACHTMAN-1966-1967 New York, New York HAROLD I. BOUCHER-1967-1968 San Francisco, California DANIEL M. SCHUYLER-1968.1969 Chicago, illinois EVERETT A. DRAKE-1969'lBlO Minneapolis, minnesota J. PENNINGTON STRAUS-1970-1971 Philadelphia, PenAsylvania JOHN BELL TOWILL-1971-1972 Augusta, Georgia BJARNE JOHNSON~-1972-1973 Great Falls, Montana HARRISON F, DURAND-19731914 t~ew York, New York EDWARD B. WINN-1974-1975 Dallas, Texas `Deceased PAGENO="0716" 702 STATE CHAIRMEN 19751076 ALABAMA - Birmingham - E.T. Brown, Jr. ALASKA - Ketchikan - CL. Cloudy ARIZONA - Flagstaff - Richard K. Mangum ARKANSAS - Croasett - William S. Arnold CALIFORNIA - San Francisco - William A, Farrell COLORADO - Denver - Wailer B. Ash CONNECTICUT - Hartford - Frank S. Berall DELAWARE - Wilmington - Leroy A. Brill DISTRICT OF COLUMBIA - Washington - Arthur Peter, Jr. FLORIDA - Miami - WL. Gray, Jr. GEORGIA - Augusta - William M. Fulcher HAWAII - Honolulu - CF. Damon, Jr. IDAHO - Boise - PeterJ. Boyd ILLINOIS .- Urbana - Stanley B. Balbach INDIANA - Anderson - Philip S. Cooper IOWA - Denison - Robert C. Reimer KANSAS - Great Bend - Fred L. Conner KENTUCKY - LOuisville - Allen Schmill LOUISIANA - New Orleans - Paul O.H. Plgman MAINE - Bangor - Merrill A. Bradford MARYLAND - Baltimore - Winston T. Brundige MASSACHUSETTS - Worcester - Robert S. Bowdltch MICHIGAN - Wayne - Matthew H. Tlnkham, Jr. MINNESOTA - Minneapolis - Verne W. Moaa, Jr. MISSISSIPPI - Jackson - William 0. Carter, Jr. MISSOURI - Cape Glrardeau - Stephen N. LImbaugh MONTANA - Bozeman - Ben E. Berg, Jr. NEBRASKA - Lincoln - Thomas M. Davies NEVADA - Reno - Leslie B. Gray NEW HAMPSHIRE - Laconla - Arthur H. Nlghswander NEW JERSEY - Newark - Woodruff J. English NEW MEXICO - Santa Fe - John S. Calron NEW YORK - Syracuse - Chester H. King, Jr. New york City - Thomas P. Ford NORTH CAROLINA - Graham - George A. Long NORTH DAKOTA - Jamestown - Herman Weiss OHIO - Cleveland - Myron W. Ulrlch OKLAHOMA - Miami - John R. Wallace OREGON - Medlord - Otto J. Frohnmayer PENNSYLVANIA - Philadelphia - George H. Nofer RHODE ISLAND - Providence - Bancrofl LIttlefl~ld SOUTH CAROLINA - Columbia - Clarke W. McCants, Jr. SOUTH DAKOTA - Watertown Ross ~l. OvIaIt TENNESSEE - Nashville W.W. Berry TEXAS - San Antonio -William E Rerriy. UTAH - Salt Lake Cty - Ralph H. Miller VERMONT - Burlington - Clarke A. Grane~ VIRGINIA - Richmond - Thomas S. Word WASHINGTON - Seattle - Muriel Mawer WEST VIRGINIA - Huntinglon - Jadklon N. Huddleaton WISCONSIN - Oshkosh - Charles F. Nolan WYOMING - Cheyenne - Byron Hiral CANADA - Eastern District - Montreal, Ouebep RH.E. Walker, Q.C. Western Olstricl - Vancouver, B.C. - Ivan B Quinn Central Dislricl - Toronlo, Ontario - John M. Hodgaon, Q.C. PAGENO="0717" 703 BOARD OF REGENTS ROSTER Presidint William P. Cki)fwe(l Denver, Colorado President-Elect J. Nicholas Shriver, Jr. Baltimore, Maryland VIce-President Jolts S. Rogerson (Class of 1917) Boston, MassachusettS Secretary Charles A. Saunders Houston, Texas Treasurer Harlet' J. Spiller (Class of 1978) Sen Francisco, California Morton John Barnard (Class of 1976) Chicago, Illinois William H. Bell (Class of 1977) Tulsa, Oklahoma Merrill R. Bradford (Clash 511978) Bangor, Maine David R. Brink (Class of 1976) Minneapolis, Minnesota Donald H. Chisholm (Class of 19781 Kansas City, Missouri, Alfred C. Clapp (Class of 1976) Newark, New Jersey Stephen H. Clink (Class of 1977) Muskegon, Michigan Jotrv M. Dietnich, Jr. (Class 0119761 Billings, Montana Milton Greenfield, Jr. (Class of 19171 St. Louis, Missouri Fred T. Hanson Class of 1976( McCsok, Nebraska Ed~ørdS, Hlr.e.yhler(Clasa of 1917) flichn(önd, Virginia Verne M. Laing (Class of 1978) Wsphita, Kansas Hu9h 1. Macnell (Class of 1971) Los Angeles, California Rcl~nert A. May (Class of 1977) Tucson, Arizona Ralph H. Miller (Class of 1976) Silt Lake Cily, Utah `Malcolm A. Moore (Class of 1918) Seattle, Washington Jullan J. Neosen (Class of 1977) Columbia, South Carolina George H. Noler (Class 011978) Philadelphia, Pennsylvania .J. Woodrow Norvell (Class of 1916) f4emphis, Tennessee W. J. Oven, Jr. IClass 011971) Tallahassee, Florida HdSS H. Oviatt (Class 011978) Watertown, South Dakota Arlhur Peter, Jr. (Class of 1978) Washington, D.C. John P. Pleasanl (Class 011977) Shreveport. Louisiana Ke'lttl*th ~. P~lngle (Class of 1977) Minol, North Ddkofa U. M. Rose Class of 1916) Hobbs, New Mexico Rudolph 0. Schwartz Class of 1978) Manitowoc, Wisconsin WillIam 1. Slewarl (Classof 1976) Montreal, Quebec, Canada Paul R. Summers (Class sf1976) Indianapolis, Indiana S. Frederick Velikanje (Class 011978) Yakima, Washington M. ~sn~melt l~lasd (Claus of 1976) Vicksbiag, Mississippi 0. Van Velsor Wolf (Class of 197d) Baltimore, Maryland PAGENO="0718" 7o4~ -- ThEANERICAN COLLEGE OF PROBATECOUNSEI. HONORARY FELLOWS HONORABLEJOHN 0. CLOCK Long Beach. California HONORABLEAUSTIN W. SCOTt' Harvard University Cambridge, Massachusetts HONORABLE CHARLES E. WHIITAKER Kansas City, Missouri HONORABLE LEON SCHAEFLER New York. NewYork HONORABLE EARL WARREN The Chief Justice(Retired) SupremeCourt Building Washington, D.C. HONORABLE WILLIAM J. JAMESON United States District Judge Billings Montana hONORABLE WARREN L. JONES United States ClrcuitJudge Jacksonville, Florida HONORABLE JOSEPH TRACHIMAN New York, New York HONORABLE WARREN E. BURGER Chief Justice, Supreme Court of theUnited States Washington. D.C. HONORABLE HARRY A. BLACKMUN Justice, U.S. Supreme Court Washington, D.C. HONORABLE LEWIS F. POWELL,JR. Supreme Court of the U.S. Washington, D.C. HONORABLE CHARLES HOROWITZ Supreme Court of the State of Washington Seattle. Washington `Deceased PAGENO="0719" (Revised July 1973) THE AMERICAN COLLEGE OF PROBATE COUNSEL 10964W. Pico Boulevard Los Angeles, California 90064 STATE INHERITANCE OR ESTATE TAXATION OF NON*RESIDENT ESTATES Real and Tangible Personal Proper*y Owned Solely by a Non*residentlJecedent COMP1L~0BY H. BRADLEYJONES Los Angeles, California FROM OPINIONS OF FELLOWS OF THE COLLEGE IN ALL FIFTY STATES PAGENO="0720" 706 THE AMERICAN COLLEGE OF PROBATE COUNSEL S0964 West Psca BQ.I~tud l5n; A~iels9yCaIitanais 90064 STATE INHERITANCE OR ESTATE TAXATION OF NON-RESiDENT ESTATES REAL AND TANGIBLE PERSONAL PROPERTY OWNED SOLELY BY A NON-RESIDENT DECEDENT ~`he toll value at cusS and tangible pernaxnl peapeety x'ilhie ta baedees aelely acexed by a naxeesideat decedent it taxed by all the States and the Dlntetot estates at nnn-eealdanla exasittiag at eaal prapeety aitxated and tangibla peesxnxl peapeexy having an actual sltxsix the elate, the greta aggregate calae of whIch steal than $2,000.00: sad Nevada has cx state inhueltanee tax at any biad. REAL and TANGIBLEP$RSOMAL.P$9$ER7Y OWNEDUW A NON'REQIDRNW DEQED~N1xAND ANOThERAS TENA~NT~.B1( ~$la ENTIRETY OR A$ JOINT TENANTS. a Alabama Hawaii 13 M$$*~hinohtt~ 2~ ~ea Mmdcx 2 Soxth Dakota 16 Alnoka 26 ldabx 5 Mixtsigan SQ Nyx~ Yack 2 Tennessee 2 Arlene. 2 tlltexie 3 Mlnnaaa&d 2 & 93 NOrth Caeallna S3 Te#as 5$ .Aehansaa 2 Indiana 6 Mlsnitaippi 1 NOrth Dakota 15 Utah 2 Os IT 4lallfernia 20s 5 loans 2 Mlstaxel 10 Ohio 2 & 20 Vermont 2 Gxtnrnda 3 Kantts 7 Maxtaxa 3 & iS Obtahama 2 VIetinla 2 Coaneetiext 11 Os 22 Kentucky 25 Nebraska 2 Orenax 19 Washington 19 S3elaueaee 2 Lnojnlsaa a Nevada 10 Pennaylasaja 9 Went VIrginia 21 Diatelat at Calambia 3 Os 4 Maine 22 9cm Hampntxire Si Rhade Island 2 Wlsrannix 24 florIda 2 Maryland 9 Nexcdeesey 12 South Caratlna 15 Wyamieg 24 Georgia 2 2. FaSvalse tuned. 2. FuS nalae tuned eseept tx the extent that the txeaivor eta retabilats that he aasxtributcd Ca the contldeeatinn tar the acquIsItIon of the property. itebeanka mahes an eneeptian far that part. amaxxt. ae prapartixe at the property onigixafly awncd by the axn'iacr and tehich the decedent did nat pay tss5 nxnsldersttnx. 3. Taasd prapartionately avexedino tx thu nxosber at 4. `Mneablet° aach as axtamohiles and bastx ace eat taaed: "Non'mavsbtes' mach as cash, eaeetry and txrxttxre are taxed. ~ Tenancies by abe entirety see not eeexoniocd; Cxtycxunity pexperty paxsixg ax thu nucaivixa spxxse In nat taxable: Jxlst tenaaeiesaee taxed to theletxlloolaeeneeptsaebpaeasnnxay bepeavedhy thottaeaiviegjoiogaaeeeoratnkeesaohaoeapI~txafly belaxgedaahImnethesesandaener ta have belanted to the decedent. S. Real property aaened by the entireties In nat txaed oxtetS title ocx changed teasa the deeeitynt ax title by the extteettes Is cantemplatios of death veil ane at thu tenanta by the entirety deaitsd.ahx.eoabpeypeetp. bY o'~It las ieye othue attqn the sxyhjvISsg.Senaxt by the entirety and the suevlclngleasnt dees ext eleot sa take by laa:Jalnt texoneie&sec'tsxed,in.talta~ltiaet abc ataeeialve taint awncet eacejax alt the extant that they ace establish that the peaperty originally tsolantrd ta hiss cc them and had apace betan eQ ty the dyvady~t. 7. Tenaxciet by the onsteety are eat rrcc~Il~tycQ. Jalssg aceatyc$eo I~t~Q~kins~nQty:tlIr ytept prtla~e~ tcxha*le tydqjhyeantrihxsted by the saralvar. S. Tensssetssby the cntteety and taint teodekies'arc xitaeecog'nleed.'lmmoaaht4 pracecty situated In Laxlsiaaaacquipedln the name at elthorotthe spreset ar in the nsmr ci bath nane the teas broantes `cansesonity aaeacocty" and upon tho death of either at sIte ncn'resideatspoosen the suscivar anhuld attn nne'halt and the dpeedext's rssate one.halt. $ Tensecist by the entirety ace ext taoed;Jxixt tenasujes see taxed pcopoesiaaatellt aycaydtxg lx the number of oaners. IS. Nat taaed. I'S. Where joint tenancy lterra~d unithin th ccc vyaca peior ax the death of a reactor oaithaot tate voxtideratton, the entire valar ha tuned tc the decedent. 22. Tenancies by the entirety are ant iaxctt: Jatat tananoirs ace xot tot etampt; hat pcopreta held ix mace that axe name in aaxodix tall except to the extent that the nst'vlvxe van estobliab he vonteibxtcd to the vonsidecation toe the avqxiultian at the property. 1$. Tenancies by the entirety ace taxed ox ha axe'hntt: Joint trnanc:es ace taacd itt toll eaacpt a the extant 5ha~ the satrvlvne ~Q5 Ottahhixts lb he oontrlbxted~to~.QqqoteaahRr*9ax t,~s. th~ veuxtohtiva xtlha nevpaytv,'to btsaal&, toeitatxx sptll~Ae'tn either t4I~elyf ltcejbQQn ~ oot~et*~,3~mPtiosn of nxe-balt.'tiaxvlvlcysfiu, ~s'l0et9text ah'cctuthaoihip to decadcnt, s'coo'li'ex oxectpxiho ~6 the catcx'ihr eat ettabfIex'tb'xt'ls~ con'tssbxsed liv' e cant at aoqxl.laion. 14. Praperay hetd by husband and altcitnottoxed. lx Wyoesint. the exte appliexto bath typexattoxuncjesofhaanbandandsulfe, 19. Tenancies by the entirety are not ceoocvioed: Joixt texaxaire are taxed In tolt exacpa to the extent that the mevixar ran establish he enntrihatctt to lbeeanaiderattca for the acquisition at the pccprrxy. In Nra Hampshire. it txcoianr ix spouse octiocat desoendana ot father or mnther af decrdent. peap~rty it exempt from tax. lx North Dakota. us hetorex sextant, there isa permmptioe that each spouse cantrihated equatly In acqxisitiun cant, 1$. Tcaanoien by the uxalecty sue oat rocofaiced: Joint tenancies are taxed ycopoetianately accoedlnt to the namber of nneeeaescePt that where propertytnhrhdtnlxlntteeaxoy byhtiahasttand atlc,theaeoyoataooneby thrdnathottheothrrahjittbrdeetttedatcanttertaxahtrstosxe.hatf otabroalar of the ahole property aatdus to joint oooecaothcc tlxyoasyoxnv,,ttseaayroat atrightsahalt be dremedatranxtee tunable prxpar- tionatchy. except that each brapticiney Is aoa taxed ox the pact thdaekt he ffiaytlrhxc acie:xally belosned lx him or sever having belonged an 17 Whtevsuex'tving henset is rither npoose oeet~ildeeo oh deordeot, ove'halt oh hhP pcopcety, bat eat to pureed $40,000.00 Is tan exempt. This provision in In the atteexahive to the esctxxiov pv,'oided Ic toat'xxpca 3 o~laji. a$l lyaC tat ~O aloimed obey any exelotion has bees made ix faxor at such sxrviolngtpousr or vhihdreo coder hootxote iv. PhopeYtl' ertrloed b~ otet%,r iolirlstsxoe ho decedcnt ned spouse as tenants by the rohirety is taxed as loose-halt. Froyerty aimilacly eece:ard ha alecedoct sod atheex an ,oiot tenants :x taxrd pecpxetionatvly. 1$. Draxdext'a istrreat in commuolty procroty is taoablr Iroex it to auruioixg spoosel: tee000iea by the eatirety are not rrooeviecd:ootxe of dccv' 39. T:et&tsplrnby liar astlirety :re tarodax I,r ace-halt: .loixt tI~a'4's~y'ies. aaaxrh, Ix real properly h~i.v been tbotItbed~ othre than holding real penperty ax trnasts by the entirety, holdiog at poapreto io move thao one sa me otth cittita ot auroiaoyshtp iterroraiaod uxder name oieoo,nstatoet. ix ohtoh roest the property as taxed iv loll escect ax the extcxt that liar tupoioor vax entoblish ho oontpibutcd to ihr causidoratlan toe the acqola' 30. In Ohio, taken the soroiaioo joiot ooorr as thu aoeoiylogtpo050. asp-knIt oh the total valor at th~ pyapeyty an txard. 35. Tenaneics ho the enticeto and Ioiot la'osOa-ies. as vaah, have beco sholiohed, loot hald:og :1 peavecla ix soare thsn oxr name aith rieht after. viourahip is ereouxiced oh en rxpcrssla yeoaidcd hoc iv the iost000text, iv ohiak raeot Ohr poa:yocto as taxed lx toll evoept: tat toe first P2.500.0th ot bnnh a00000is lad shoyrvay savivex acraaots a Fedoval Svajvvs aad l.',ao Auxao:otiaoo aith sxeoiainenpoo sr denoendant or parentl lh).toe saW. ix case ahtuv,aisa tpausp: sod lo) Ia colcot toy-bar Iloeludion epaoxrl Pox raid bush ooxtoahutixs otvooaidecaxoe Ice acqulsltiax $5, Trxanolrtbythernhlretya.resot eeraooiard.Jaiotteooopiesarrlaxedproyootioxatulaiyvoedinohohhenomberofowxrra. $5, Tenancirs by the rntieety are s,'t croagoloyd iv Miovyvyta. 34. Fattostor taxed except to the cotro that thusaca,oaeoaorxtohltah thai he yontaibated the osayerto aycovxidepsllon top its areaxisilins. 5f ocxoired by tihi, broorat, devise ye ,ohpeiteopc hy droa-dy,:i 00,1 500 othrypevaoo ioiott", thr pr:'cvriy as taxed prxportianxtcty acnaedist In the camber at oonres unless the instcxo,eol reratiot tack oaores)iip oreates aotrerats ix a dillerrol p0000etaon. Texancire by the esllrete accent $6. ll~eet by cls~.f~aW~r.oh reel oatLtocssibuo pvyvavol pcoaaeeto kward by a 000'eevttlrvx bob does cOltS thaaudc lii to9t'nih~culsntsiYfltI9prBp$~tio axty It it ha. acqaleed a satoa ix Ileotoyko ao,l ix vol taxable ylteahrve. 3$ Atsaha's tax Is the proportios oh the albo:"aklr pcrdit Ivam Frdrctl tat thsl hhr trcta valor ~l ihe Omaha property heart to the entire great ecxate mhrrrxersltxate. and trots palate a drhioed ha ,l,yryi v'lrcevre iv Aratiox 3031 tat at the IOU, atth the erta It that Fedreal contrIbution rxhna apply In determining baa etaeh. :lano, ,,t :aavajv held asaoao till vIa abe fcoaaextate oh the drorda-ot. PAGENO="0721" 7:Q7 INTANOISLE PERSONAL PROPERTY All Statet of the United States and the Dietriet of Columbia eithr5 have laos prcbibjllog isvos:oo or peyv:dr for ree~pySçol exemption therefrom mith respect tointssgible personal Pe~~ Isinfiaviha ~ oiumse~lhxso~sitis~ft tRotS borders bxloo~i5g ty.o person who deed a resident of soother state of the Dotted States, except: 1. Kaessss taxes sorb intongiblr personal propOyfu if fe not taxed or nnflmitt~d fgt t~tvetlye ix the state of domicile of the decedent. 2. Tense tseasintangtblr personal propexty nocept ohere (l)dtste of doioielieoxf drdrdens does oot tao ioloogibfea of residents yf Toots or (2) sash state has & rroipyeeity ntatote. 3. The St*ths of Csiiforni~ Iclorida, Masonclausetto, Sooth baEas~ia, Utah aOiOWssitlhgtoo tail adeb ixteogible peroooal property cettex owned by a nos'resideot of tar United States 4. The Diatetgt of Colombia Ixoes intangible personal property when owned ho art step, whether rreixfynt venal, of ttse~ Unitad5tofla. U Mixdsni~f~b~ iddeti$d~yaxntiy5ssica1e and stow daoatdflt~ftgihti Peesenal procterty cal 5 oon.eroidoss(P[oosa Oat 265.RaaalanSoasttcn IPSO). 6. Coleeadis'tt Peeiproeity statute rosesdx to iotangiialr pernonal property having an aetast or badness altos xnithio the State owned by a reddest of the Ueiitad States. 7. Arkaasa~ dean not distinguish between tangible and intanriblr penitonal property and latex all property of a non.resldeot of the state lensted is Arkansas esrept If aoothei state rxrmpta Arkansanis which rai~ the riremptios in rsnipeooal as in the ton on all property. 8. Wisnonots does eat tax a non-resident dsrrdesfny&fncitraf fycisperty taOS haciog an Ortoal sitsasia the state if a like exemption is fanny of Wisnoasis residents Is allowed at the time nf decedent's death by ttte state yf his rrxidrrre. 9. Kentisetsy taxds intangible personal rrotsrrty accord tip a otio'rrsidentdeeedxnt if it has orooirrd a business allot is, the state. WAIVERS Waivers fe )~ ajfls,Ofg~gdk 5(adbstthatio rosfzaeatins costed by nox'rraidpnt deerdyetis are reqoieed it the fotlawfisgos~tya aad applixatisn thernise slsmsld braddeessed as indicated: AIshtiti~.'.. .`~ ~, Commissioner of Rsceoae StatnDef.dilmrot ccfll,ryznar Rotate Tao Division - Mn$snmery, A)pbar~cn AI18ti~ . .. Itepapaxeist of Ranenact Voeieayz. Alaska Arizona Ariec,ya Eatstr Tan Comsoiseinnrr * StahCsppi9oI lln5dipg Pfceonlo, Arizona Californis Inheyitaaeo Tax Attorney Staid Cnntxolfern Office U*~OI0OambIa..,It~~vxeOfftae5 itheeoar Ditioioa IflberftnoveaaciEatatd Tin Seettun Montelpal Center Woahi5gtyo, b.C. 20001 1I&Wstt .. a thesitsoy of ~aooli0n * 0$ateafPt5woti l5c~scolcilca. Hawaii IdahO State Tao Comminvlorn )stlferi'tdnxe `lot l)ieltiscn Peat Office-Don SO Boise, Idaho 03707 Jthnats 1. Aticcyisoy (lenient ildiYllortt. La Sil.lle itceet Chtnogar, tlllnoia dosaix Ss4totts tnfsttelt0xen `tax Adrx)tclvsratnr toagtarttornt of State Reoenoy StAid Office Itolldictg Istdtaoayciltn. Indiana Xsnsasp . s s~ yyx... Esarenloy of Rev~na~ Slate Commission of Rrarnoe sod Tnaatiox Ttcpdlta, liaonaa Mispbtgaet;.a...,s. StataDrpaiIocentnfhrneour tplxcsS~aoor TaX DivisiOn I~aBri0s. Michigan Misslosippi State Tan Commissioner Jeabso~,Mire)ss(ppi PileoOYsr,k 4 Depaitatont olTaciatiors MisrrllxxpacxsTao lhcereaa Trops(oy ond Estate Ten Sentioss Suilçt)og 9,Campx~Slfa Atbatcy, Nice dark llldkO )SessMesieo Soeeao of Reaeoae Saolrs5poc Tao Dlois)*ta Santa Pd,Newteenioe North Cseotixa. , , , Commissioner of Rooroae Ralelgto, Noith i7aenling Oklahoma Estate Ton Dotsi~rc Cspitol Soildiog Oklshoma City, Oictahardtt Pcraxiayloaoia ttzpsctment of R fsvtoesitenOe TsR Dto)tiorr Harrinbosa, Penrieyltspaia Scsfth Carolina... .. t7lrectxr oS Es(atr Tax Dtnttiori Sooth Carolina `Ito Commission Post Office Rex 110 Cot~mb)a. Sooth Carolina #9202: Soath Dakota Cxmmisniooec of Renenae fntscrltatsoe `lan Dlnitiots Pincro. South Dakota Tenoetoas Com~o)anlaoos of Rrresug~ 226 Caplxol blat Nitehoitlo, teonrsiez 37219 Texan Stole Comptrotlosof PxbltuAeaOasitg - Aastln.Teoas Utah State Tao Cornmissiats Capitol Oxildlog SnIt Lake City, Utah Washington S Department of Rrector Inheritance Tart Dioisiutt Otimpta, Wsshiogxais 9S504 West Virginia State Tao Commissioner Cap)t~l R.oi)dlng Ckaclrtson, Wrat Visginla Wynroiog lxhrc'itance Tax Cammtsniosst Drpaetmeot of Rreeoos 2200 Carey Aoenbe Chcyrnnr. Wyoming 82001 JWaieestA*5 l8OTrc(ottuzdbt the fcctloo'arg States: Ast(atssat, Cotorsdo (t), Conoretleat, Delaoarr. Florida, Oeorain, Iowa, Itentacky (7). Lox(iia9a, Matrse, MsrplaesdntuaspspehosnttR Minnesota (3), fstiaooorilai). Mintana. Nehrattia, Nrnsda, New Hampskire. Nesa Jsrsry, North Dakota. Ohio. Oiegnis, Rhadifeinad, Versanes, Vieginia, Wisconsin (0). -, 1. Waivers aer NOT rcqxiprd in Cotnrado lIStLESS the stoch bass basloros nitos or aetxal titus in the state. - - 2. In Illinois, stook of dcv)crtie corporation it rsrmpt oolrsslt wan "ored or rwployrd in carrying on a business in the Siafe qf Illinois"; affld0vix of noy'yarideyey, Parer a43, rota be obtained from the ItlInois Aiieeoey i'leoeral'sCbgoege Of6ixd;'ias dOOfi - Ittttidia repealed ita general rrcia,remrnbs for waivers for troosfex of aeouritirs. baak atnoorstr and intangible psesnoappi5901iy 7 fceloogiog to ooo'rraidento. 3. Mlnozsnta nolooeer c'eoolces a wnircr for trnnofzrs oe stock of a Minnesota corporation. However, an dfIiriaciit o(ooo.reslcfettey an a fyrrp obtained frccoy the Commiailonpr of Tsoalloo, mast be filed is dopteate as prcvideci in Mion, Stats 291,19 tubt*. 5. 4, ~Wasoee5 air NOT reqaiepd in Ned York ecerpt whrrc the otnrestln any oos detessailn corpors,tipn auneeds$2,aaotoslglsadi - - aaiiae Pxcxcn 249'p of thc Nrw York Tax t,acn, 9 - Washingtnrr inheritanec tao it ifnpofxd ccoly onastatesof presons nhn are tot rcnidenti of any otote or territory of t~ce U.S.A. ithia dues not nreensayjty pticoirsste alt adminiatralior rpcrolxrmeryts of 0 ceaivxr). 6. Wisconsin DOES require o osiver ccc "consent to transfer' from rho Dpparonoot ef R roenoc nhrre the dancdolttia aitisiditig oft state which docs tot imposr a dxattc tax. 7. tfrotoxky no tongre re5aiecs s wsiy-rr but on offidgylt masf he filed with a tranaf~r agent stating that the Ooo'restderct dreedest had xx property Ooklretto Kentorbo loheritance and ratalr ton, The affidaoia is filed by the personal rrrrrsentetivr and a copy in tarnished fcc thc Drpuer,nret ct g cornice. 6. Sliuooori rrqalerr that the eco'poratiov is xhich the decrdrnt owned otoch be prxaided sn afftdsvi( of dg~edrsr5'a non.sesidrsey Otto form xpproord by lhr Attorney Orocral of tilissyari. which ms' fin obtained from the Bureau of Itohrrltaoos Ton. Dspartmyot of R rornor, P o, non 27, .trffs'esas CiW, Mi~coei 05101 Copyriflct, July, 1973 68~872-i6---4O PAGENO="0722" (Revised January, 1970) 708 THE AMERICAN COLLEGE OF PROBATE COUNSEL, 10964 W. Pica Boulevard Los Angeles, California 90064 APPLICABILITY OF UNITED STATES ESTATE TAX AND GIFT TAX TO NONRESID~rIT ALIENS Compiled by Richard H. Pershan, F.A.C.P,C. New York, New York ESTATE TAX Property Subject to Tax Subject to the death tax conventions summarized in Ap- pendix A, the following property of a nonresident alien Isa. a sitsis in the United States and therefore is subject to the United States estate tax: 1. Real property located 1st the United Staten. 2, TangIble personal property located In the United State. except works of art on loan for exhibition in a public gallery. 3, Shares of stock issued by a domestic corporation, regardless of the location of the certificates. 4. Debt obligations, including bonds, Issued by a United States person or corporation or by the United States (except currency and, if the decedent was not engaged in business In the United States at the,time of his death, obligations issued before March 1, 1941) or a State or political subdivision thereof or the District of Columbia, regardless of the location of any evidence of indebtedness, except items 6, 7 and I described below under Property Not Subject to Tax'. 5, Sfthedecedentdies after December 31, 1969. de- posits with a United States branch of a foreign cor- poration If the branch is engaged in commercial banking. ~. Interests in estates or trusts to the extent that they consist of property having a situs in the United 5tates. Property Not Subject to Tax The following property of a nonresident alien has a situs outside the United States and therefore is dot subject to the United States estate tax: 1, Seal property located outside the United States. 2. ``ranglble personal property located outside the United States. Property Not Subject to'I'ax (Continued) 3. Works of art on loan for exhibition In a public gallery in the United States. 4. Shares of stock issued by' a foreign corporation, regardless of the location of the certificates. 5. Amounts received as insurance on the decedent'a life. 6. Deposits with a foreign brancls'of a United States corporation or partnership if the branch Is en~ gaged in commercial banking, 7. Debt obligations of a domestic corporation if any interest thereon which the decedent were to' re~ ceive at the time of his death would be trettede for income tax purposes, as incpme from sources without the United States~ 8, If the decedent dies after November 13, 1966 and before January 1, 1976, deposits with corporatloa~ or partnerships carrying on the banktngbuslness, deposits or withdrawable agcouyts with saving, and loan associations, and amounts held by an insurance company under an agreement to 9ssy interest thereon, if any interest thereon which the decedent were to receive at the time stlsis.death is, for income tax purposes, not effectively con~ nected with the conduct of a trade or business In which the decedent was engaged within the United States. 9. Debt obligations, including bonds, issued by a foreign corporation or government, regardleu~ oi the location of any evidence of Indebtedness, Miscellaneous Provisions 1. For estate tax purposes "notresident" means "zson. domiciliary". 2. The gross estate of a nonresident alien is made up in the same way as the gross estate of a citlten 0*' resident but Is confined ts property which is PAGENO="0723" ~cliscellaneoua ProVisions (Continued) situated in theUnited States. Thus it can inc)ude jMntly-owned property, general powers of appoint- rne*tt, ~evocable trusts. etc. 3, 3c~,op~rty of Which a nonresident alien made a trans- fer taxable under lOt. Rev. Code (52035--2038 (transfers in contemplation of death, with retained life estates or taking effect at death, and revocable transfers) is subject to tax if Situated in the United States either at the time of transfer or at the dc- cedents death. 4 The estate of a nonresident alien is allowed an ex- emption of $30. 000 or. in thc ease of Switzerland and all the countries listed in Appendix A except Canada, Ireland, South Africa and the United King- dom, the larger of $30, 000 or that proportion of $60. 000 which the value of the gross estate situated in the United States bears to the entire gross estate wherever situated, S. Charitable deductions are allowed only for transfers to American beneficiaries. 6, DeductIons for funeral and administration Capenses. claims against the estate, unpaid mortgages, losses, and death t8xea on charitable transfers are allowed only in the proportion which the value of the gross estate situated in theUnited States bears to the value of the entire gross estate wherever situated. It is immaterial whether the amounts to be deducted were expendedor jncurred within or without the United States. Where a nonresident alien owns property situated in this country which is security for a debt for which he is liable, the full value of the property, not merely his equity, is taxable, but thedebt can be deducted only proportionately. .c.~x, ~n~Farmers' Trust Co. v. Bowers, 68 F. 2d 909 (~d Cir.), cut. denied, 292 U.S.. 644 (1934), How- ever, where he is not liablefoi' the debt, only the equity is taxable, Estate of Harcourt Johnsione,19 T~ C. 44 (1952). 7. No marital deduction is allowed to the estate of a nonresident a'li~h except that the convention with Fpapce p~ovidee for a proportionate deduction. The option to have taxable property valued as of a date or dates subsequent to the detedent'u death (alternate valuation) is available to the estate of a no~re,tdent alien. The amount of tax on thetaxable estate of a non- resident alien is: Taxable Estate Tax No~ ovey $100. 050 . 5% of the taxable estate 709, ___________________________________ Over $500, 000 bItt not over $1,000,000 $48,000, plus 15% of excess over $500,000 Over $1,000,000 but not over $2,000,000 $1ZO,000, plus 20% of excess over $1, 000.000 Over $2,000,000 ,,,,,, $320,000, plus 25%óf excess over $2, 000.000 10. The credits against the estate tax for (a) state death taxes, (b( the gift tax and (c) the estate tax on prior transfers which are allowed to estates of citi~enu or residents are equally available to as. totes of nonresident aliens, except that the maximum credit for state death taxes cannot exteed an amount which bears the same ratio to the credit (computed without regard to thi, limitation) as the value of the property upon which the state death taxes were paid, and which is includable in the gross estate, bears to the total groes estate for federal estate tax purposes. No credit is allowed for foreign death taxes. 11. A preliminary notice anti an estate tax reiuTrn must be filed if the part of the gross estate situated In the United States excee4s $30~ 000 on the date of death, Property Subject to Tax A gift of the following property by a nonresident alien is subject to the Unitetf States gift tax: 1. Real property located in the United States, 2. Tangible personal property bOated In the DMted Slates. Property Not .$sbject to Tax A gift of the following property by a nonresident alien is not subject to the United States gift tax: 1. Real property located outside the United States. 2. Tangible personal property located outside the United States. 3, Intangible personal propertyp wherever locatC& Misceijaneous Provisions 1, For gift tax purposes "nonresident" means "noes' domiciliary", 2, The $3, 000 a~~ual exclusion Ia avaIlable to ssosi. Ova $100 000 b resident aliens, but the $30, 000 lifetIme exemptIon over $500, 000 $5 000 plus 109 of is not, except as provided On the conventions with excei.,ove,$lOO póo. straNa~od~a~n, GIFTTAX 8, 9, PAGENO="0724" ~ITUSR3JLEI IN RSTATE TAX CONVENTIONS BILL OF EX- CHANGE AND ACCOUNT BANK PROMISSORY BOND GOVERNMENT JUDGMENT SHIP AND COUNTRY BEc~I\tABLF ACCOUNT NOTE (CORPORATE) SECURITY DEBT AIRCRAFT Location of Debtor s Debtor' location of Where Plate cf bank recidrnce renidence1 government originally regIstration Oltainesi ~ Debtor' Location Debtor Place of in- Physic~1 iooa~ Whose re- Place of renidtnce of bank residence car porattots tins of cecti- cOrded fegiitr*tlon ficate if iii bearer foitnl place of regis. tratist't, if vegiatsieci ~IVJ~RUL~S IN ESTATI~ TAQNv)plT~ON$~ (Continued) lsuth Africa P. S. if dom.. Sante as location of Same as no- Sante as he- Where cc- Place of Idled in account document4 count recely. count reedy- corded registration P. S. ;S. A. receivable able able if ordinarily ?esident in S. A. Vnited Xingdom Decedent's IDecedent's Location ~f Decedentt~ Decedent's Where cc- Place of domicile domicile document domicile domicile corded registration ~1. ~uoin~s debts situated is state where business is located if donor or decedent is domiciled there. 2. Ito provision In gift tax convention. 3. For negotiable promissory note, the residence of maker, 4. 31 nonnegotiable. at domicile of decedent. ~, Bonds and oilier negotiable instrumenle In bearer form excepted. 710 S __________________________________ 3. ~itk~ritOb~e deductions are allowed only for gifto to 5. CiSc to third pernono may not lie split between American beneficiaries, husband and wife if either is a nonresident alien. 4 ` 5il~stept hO tirovided l's the tohdetttiot with A~ttralia, 6. The rate of tax is the name for nonretident aliens ho enkrltdl dedssctiSO is allowed toasonres ident and for residents or citizens. a)ien dogor. Aoots1biia (`GSII hod' Debtor's Estate Taxes) residence1 Canada a' FinIld France Greece Ireland Daly , Japan (Gift and Estate Taxes) Norway ri~stoe's Decedent's dominic Decedent's domicile Decedent's dors,i~iIe Debtor' fecM~sce Debtor'n Debtor's locati~n Dchtor',, Place of its. Debtor's of bank renid once cot porabiors residence Decedent's I)ro't-rr'o Dccrdcnl's Decedent's domicile residence3 domicile domicile Deftddnt' 0 Drawec' s Dectdest's Decedent's domicile residence3 domicile dotnicile Decedént'n Location of Decedent's lDecette'st's domicile document domicile domigile Debtor's Debtor's Debtor's Debtor's itsidence bdiid eons residence residence Debtor's Debtor's Debtor's Debtor's residence residence5 residence5 residence5 Location Lodation of Same as bill lame as bill of bask document of exchange of exchange. Debtor's Place of ieside~ce registration Decedent's Place of domicile registration Decedent's Plate sf domicile regtitratlon Where os. PlaCe of corded Oefie5bat3o~ Debtor's Plate of residence registration Debtor's Plate si' residence registration Debtor's Place of residence registration Coppright ~ ~lanuAry5 fiG PAGENO="0725" 71.1 SUPi'LISMnNTAL ~UEMISSiON or ~r~rs~ A~annxc~ CoLLuGE' or PE0BATE Cour~sEL IN Coy~ncTIo~N WITh TillS 1l~STATE AND ~lirr TAX HEARtNaS Or ~XXE CO~fllITTEE err WAI5 AND MEANS OF TIlE iJ,S. II~i~sn or Rnranssrrra~czvns This statement supplements the March 12, 1976, written statement, submitted in letter form, together with the oral testimon~y given March 17, 1976, by William P. Cantwell, Esq., President `of The American College of Probate Counsel. This statement has been prepared by a diiiy `constituted committee* of the College and Is being made, under the dixeetlo~i ~f its President (Mr. Cautwell) and President-Elect (J. Nicholas Shriver, Esq~). Following irttrôductory points on the general philosophy of this committee with respect to estate and gift tax reform, the statement makes some suggestions for improving the operation of the estate and gift tax system. A. PhILOSOPHICAL GIJIDELINES The history of the Federal estate and gift tax system and many of the obser- vations which have l~een made during the course of the current hearings, show that there is little consensus as to whether the purpose of the system is to break up large accumulations oJ~ wealth or to raise reven~ie. As a practical matter, the foundation of the system probably rests upon a combination of these purposes. However, those purposes, and the efficiency of the system In achieving them, can not be the only criteria to be applied in judging the system. Other significant criteria, include the stability of the system bader which estates can be planned in reliance that major changes in the law will not render the plan useless (or worse) by the time the property owner dies; the 14nderstandd~biiitV of the system, at least to the average attorne3r, so that It can be dealt with competently in carrying out the clients' wishes (while an equitable system is desirable, It Is not always pos~lble to develop a simple and understandable tax structure `that Is equitable-~-strjving for equity often results*in `complexity, creating problems of uuderstandabillt~ to property owners and their attorneys) ; the aeutraiity of the system, so that actions need not be distorted~to achieve tax object1vei~'and the certa4nty of the system (a corollary~ of both understandability and neutrality), a principle `recognized by the Congress In keeping the Federal estate' and gift laws basically unchanged since the' msrltal deduction was brought In by the Revenue Act of 1948 and the present method of taxing po'wers of appointment was adopted in 1O~L , ` Achieving `certainty of application of the estate and gift tax laws sometimes runs counter to obtaining complete equity since, in striving for the'latter, uncer- tainty Is all' too often created. (A key illustration of thiS is what happened to the provisions taxing accumulation: trusts during the enactment of the Tax Reform Act o~ 1969.) `This Is more Important from the' standpoint of the property' owner than from that of his lawyer, since uncertainty in the application of the tax laws creates additiOnal costs for the property owber and Increases his lawyer's fees. Another desirable~ priac1~pie Is that the laws apply un'iforthly' to' similarly sit- ,uated taxpayers. However `it' is not always possible t~' achieve these results without losing other objectives. For exaniple, an unllmit~d marital deduction (or even the present fifty percent marital deduction) penalizes people who die un- married and an argument could be madeth one's marital status at death should fiot determine `the amount of the federal eState. tax; on~ the other hand, the elimi- nation of the'marital deduction would bring `back the inei~ulties that existed between the eight community property states a'nd the rest of the country prior to the Revenue Act of 1948, and run counter to the Social' policy of' easing the Im- pact on surviving spouses of the estate tax on 4he estate of the firstie die. The rights of the taxpayer `must alto be considered In any tax system. The ta~psyer (in the `case `of the' Federalestate tax, it Is the decedent's' `estate), If Insufficiently lIquid~ will find that the pdyment of the federal estate tax Imposes a great hardship, sometimes forcing the sale ~of family farIna, ranches or. small businesses or loss of' the family residence. Easing. the burden of the tax Where an estate's `assets'wre relatively' Illiquld Is an exteflslon of the abilIty to `pay principle since, in an~iLliquld situation, there is inadequate ~bility to pay'the tax without forced sales. , " *The committee membersa~e' listed' attbe end afthls stateibetzt~ ` ` PAGENO="0726" 712 Last, but not least, taxpayers should have the right to expect an efficient system of tax collection. In most cases this should lead to the earlier closing of estates, while providing for extensions in those situations involving lack of liquidity or other hardships. B. LIQUIDITY PROBLEMS One of the most important problems in the Federal estate tax area involves the illiquid estate, whether it be illiquid because its principal asset is the family farm, a closely-held business or some other asset, the forced sale of which would cause considerable hardship. Many proposals have been made to deal with this problem of liquidity by giving special treatment to certain types of assets, such as farms, ranches, open space or historical sites. We reject this approach because it violates the criteria of neutrality, uni- formity and equity. It could readily lead to the creation of new estate tax shelters, while failing to cope with the problems of most illiquid estates, regard- less of their assets. Instead of special treatment for certain types of assets, we recommend other changes. These are designed to relieve the hardship faced by all estates by establishii~g rules that set more liberal, objective standards for the grants of extensions for payment of Federal estate taxes. 1. Broaden definitions of closely-held businesses eligible for deferred payment of estate ta~r (a) Section 6166 permits ten-year installment payments of estate taxes attributable to a closely-held business for up to ten years (if the value of the business exceeds either 35% of the gross estate or 50% of the taxable estate) and, broadly speaking, defines a closely-held business as one in which 20% of the value of the business is in the decedent's estate or in which there are 10 or fewer partners or shareholders. We propose that the definition of an interest in a closely-held business be broadened to deal with situations in which an estate may be unable to pay the tax because its assets consist substantially of an interestlh an unliquid business which does not meet the present tests. We propose broadening the Section 6166 definition of a closely-held business to include a business 20% or more of the value of which (or of the voting stock of which) was owned either actually or constructively by the decedent, or the stock of which was not traded on an exchange or in the over-the-counter market. This would expand the definition of closely-held business to cover nearly all cases where the shares of a corporation may not be readily sold at their approximate fair market value. Constructive ownership rules attributing to the estate stock owned by siblings, descendants and ancestors (and spouses) should be applied. These would extend the Section 6106 treatment to those situations where the estate owns less than 20% of the business but, for practical purposes, the estate is no more liquid than if it owned more. This is because diffusion of ownership among family members is unlikely by itself to result in diminution of the liquidity problem, particularly because of the difficulty in selling a ~inority interest in a closely-held business to an unrelated third party where other Important shareholders are members of a single family. The alternative definition of a closely-held corporation-that It have ten or less shareholders-should be replaced by a test as to whether or not the stock is traded on a securities exchange or in the over-the-counter market, since this really deals with whether the estate is in a position to liquidate its shares, regardless of the number of stockholders. (b) Another serious problem for the illiquid estate forwhich a deferral has been obtained may arise because a withdrawal from or a disposition of the interest in the business can, under certain circumstances, cause acceleration of the remaining installments of the estatO tax, without providing the estate with sufficient liquid assets with which to pay it. Section 6166(h) (1) (A) provides in substance that, if withdrawals from the closely-held business equal or exceed 50% of the value of such business, or 50% or more of the closely-held business is sold or exchanged, the payment of the remaining Federal estate tax is accelerated. There appears to be no justification for an acceleration of the Federal estate tax regardless of the percentage of the closely-held business which is either withdrawn or sold, so long as the withdrawal or sales proceeds are applied PAGENO="0727" 713 substantially to pay the remaining estate tax due, and, in fact, the statute pro- vide~ for e~ecptions In the ease of a sale or exchange, where the proceeds are used entirely f~r the ~aymen~ of Federal estate tax. But not all of the proceeds should hare to be applied against the Federal estate tax to prevenj an accelera- tion of estate .tax paymeilts. Some of these proceeds will be needed to pay state 4eath taxes (or, other debts) which fall due during* the ten-year period of the Section 6166 estate tax installmei~ts. If sectioi~ 6166 requIred all of the withdrawn funds or sales proceeds to be applied to the Federal estate tax, the executor who used such funds or such proceeds to pay state death taxes would then have to borrow an equal amount of funds to apply on the Federal estate tax at the next installment due date. This hardly helps to alleviate the monetary problems of the illiquld estate. We would recommend that the exception to acceleration apply if at least half of the pro- ceeds are applied agaInst the Federal estate tax. A similar problem arises under Section 6166 (h) (1) (B). This makes an excep- tion from the general acceleration provision where there is a distribution in redemption of stock under Section 303. The last paragraph of subparagraph (B) provides that this exception will only apply if an amount of the estate tax not less than the redemption distribution is applied on the next installment of the Federal estate tax. This requirement that the entire distribution be applied against the Federal estate tax causes the same liquidity problem noted above, namely, that where a distribution is necessary to pay the state death taxes or other pressing debts, it is then necessary for the executor to thereafter borrow the same amount of funds to apply against the Federal estate tax, thereby com- pounding his illiquidity problems. Again we recommend that only a portion of the redemption distribution, such as half of it, be required to be paid on the Federal estate tax at the time the next installment Is due. We also recommend defining a "disposition" under section 6166(h) (1) (A) (Ii) and a "distribution" under subparagraph (B) so that, when notes are received in exchange fo,r the corporate stock, the "disposition" or "distribution" would be deemed to occur only when payments are made on the notes or the notes are pledged for a loan. 2. Set objective standards for reasonable cause for deferring payment of tas, and est end the period to 5 years In addition to providing for more liberal relief through permitting Installment payment of estate tax over a period of years to be available to a broader class of elos~y-held bdsinesses, we believe that the twelve-month extension under Sec- tion 6161 (a) (1) (permitted whenever a fiduciary can show reasonable cause for his ifiability to pay the estate tax when due) should be available on an objective basis, rather than giving the Internal Revenue Service discretion to grant this privilege only if an examination of all the facts and circumstances discloses that a request for an extensioz~ pf up to a year is based upon reasonable cause. We alsa believe fhat this extension should be for up to five years. The Lenate Finance Committee Report to the Excise, Estate and Gift Tax Adjustment Act of 1970, gives six examples of cases in which there would be reasonable cause for an extension: The first example Involves situations where farms or closely-held busi- nesses comprise a significant portion of an estate, but not enough to satisfy the percentage requirements for obtaining a Section 6166(a) extension. Although these' Interests could be sold to unrelated persons for their fair market value to obtain funds to pay the estate tax, the executor could raise the funds from other sources if be had more time. The ~eco~d example deals with an estate of sufficient liquid assets to pay the tax whefl otherwise due, where the assets were located in several juris- dictions and not immediately subject to control of the executor so he cannot readily marshal them. The third example is of an `estate a substantial part of whose assets consist of rights to future payments (annuities, copyright royalties, contingent fees or accounts receivable), where there Is Insufficient cash with whIch to' pay the estate tax when otherwise due and a loan cannot be obtained, except upon terms inflicting loss upon the estate. in the fourth example, the estate Includes a claim to substantial assets which cannot be collected without litigation, so that the size of the gross estate is unascertainable as of the time the tax is otherwise due. PAGENO="0728" 714 The fifth example deals with asset which must be liquidated at a sacrifice price or in a depressed market, to pay the estate tax when otherwise due. In the sixth example, the estate has insufficl~nt funds (without borrowing at a higher rate of Interest than that generally available) to pay the entire estate tax when otherwise due, provide a reasonable allowance for the family during the remaining period of administration and satisfy claims against the estate. The executor has made a reasof~ab1e effort ~o convert assets in his possession to cash (other than an Interest in a closel~-beld business to which Section 6166 applies). In all six of these cases, we recommend that an extension of time ,t~ pay the tax for up to 5 years be automatically granted upon representation of the exL~tence of the problem in a sworn affidavit from the executor. This would still, leave to the discretion of the Internal Revenue Service other cases where an examination of the facts and circumstances discloses that a request for an extension for up to five years (presently twelve months) Is reasonable. Ilowever, in these other cases, the Code should require the Commissioaer to grant such an extension unless he determines that there is reasonable cause not to grant one. Should it later become apparent that the taxpayer submitted false or insufficient intor- snatlon, existing civil and criminal penalties are adequate. The liberalization In 1970 did not extend to the discretion given the Internal Revenue Service to extend for up to ten years the time for payment of any part of the estate tax in cases of undue hardship under section 6161 (a) (2). Such an. extension may be granted only for a year at a time and requires more than a general statement of hardship or showing of reasonable cause to obtain it. Undue hardship means more than inconvenience. It means sale at a sacrifice price or in a severely depressed market or the disposition of an interest in a family business to unrelated persons, even though it could be sold at a price equal to its current fair market value to these people. As pointed out above, we reeommend that the time period for an extension of the estate tax payment for reasonable cause, under the criteria of sectiOn 6161 (a) (1), be extended from 12 months to 5 years and that, thereafter, the undue hardship criteria of section 6161(a) (2) be used for further extensions. 3. Lengthen the maa,imum e~ten~sions to 20 years The present maximum peripd for obtaining extensions of time to pay estate tax undOr sections 6161 and 0106 is 10 years, but an extension under section 6166 must be elected at the time the return is filed. We recommend that this election also be available if a deficiency is assessed and furthermore, that installmen~ payments of the tax under the conditions described in both seCtions 6101 and 6166 be permitted for up tO 20 years. 4, Reduce interest rate on ea,tengions to two-thirds of' that on deficiencies Finally, we propose that in all cases where the `payment of' the estate tax is to be deferred under sections 6161, 6168 (dealing with ettensions for the payment Of estate tax attributable to a future Interest), 6166 and the new extension pro- visions advocated by us, the interest be reduced to two-thirds of the rate cur- rently charged on deficiencies. For many years, until 1975, interest wasimposed at only a 4 percent rate on extensions of time for ~sndue hardship (section 6t81~a) (2)), because of a future interest (section 6163), or ~vhere there was a cio~ely held business In the estate (section 6166), although the re~u1ar 6 percent lnt~rest rate applied td twelve-month extensions under section 6161 (a) `(`1). Effective June 30, 1975, the preferential rate Of interest was abolished at the same time that interest rates were raised to 9 percent (now 7 percent, at least until February 1, 1978) The Senate `Finance Coñitnittee etplanation of the change' thCt eliminated the preferential interest rate overloOked that ~state5 horning closely held businesses and other Iillqtiid assets must not onl~r earn profits to pay the interest charge, but also to pay t~ie unpaid installments of estate tax. `We merely seek to further the pufposes of thee*ten~Ion provisions as originally enacted and the liberalizations as proposed by us, by ~reinstat1ng a preferential `interest rate which `would rise and fall In proportion to the current rtte of interest for'income tax purposes. We believe that the adoption of the above proposals *woul~'go a long `way to solv~ mOst lionidity problems experienced by estates. From the standpoint of sound tax policy, the uniform application of these provisions, regardless of the nature of the `illiquid assets, would further the objectives of neutrality, equity, PAGENO="0729" 715 aiuj uniformity of application of the estate ~ax laws, as well as providing cer- tainty that relief would be available in ~uostcases. 5. Cre~te a new alternative valuation cOncept for Mr4-to-vah~e assets Great difliculties are created for estates holding hard to value assets and for the Internal Revenue Service in dealing with these assets. Current rules require appraisals, which can J~e e~pensive, can result in expensive and time consuming controversies with the Internal Revenue Service, and may result In unfairness to one side oi~ the other *hen assets are sold within a reasoilable period after death, TberefOre, although we favor retention of the 6-month alternative valun- ti~n d~te, we recommend that where an estate holds assets described in section 6161(a) (1) or 6166, o~, real estate or tangible persoi~al property (other than property which depreciates in value due to lapse of time or normal use-such as the family ear) at the time of filing of the return, the executor should be permitted t~ elect ~ deferred alternate valuation date for such property (separate from the normal election as to valuation dates) that would permit the valuation of these assets to be postponed for a period of up to three years following the date of the filing of the return, with valuation to be fixed by actual sale or, if none, by appraisal at the end of the period. Needless to say, unless otherwise deferrable, the Federal estate tax attributable to these illiquld assets should be paid on an estimated basis and the statute of limitations as applied to ques- tions affecting tbe~e assets tolled. C. INTERSPOUSAL TRAnSFER$ The problem of inter vlvós and death-time Interspousal tratisfer Is one that has produced a number of proposals to make changes in the marital deduction. We are concerned that some of the more far-reaching ones which would provide for the unlimited marital deduction, making all interspousal transfers tax~free, would create both an unacceptably high revenue loss (at least in the near term) and run ~counter to the objective of having a stable tax system. The two most serious problems in this area are the artificiality of the legal presumptions in- volving joint tenancy, particularly between spouses, and the tax pressures to distort a client's natural desire in making appropriate dispositions for a spouse and children. This is particularly serious where the client wants to be sure that his or her children, and not a second set of children the surviving spouse may have on remarriage (Or even the surviving spo~tse's new marriage partner) share in the estate. Such pressures exist even more strongly in second marriages where there are children from a first marriage. 1. Inter vivos tran~8fers of joint and community property We propose retention of the 50 percent marital deduction in general, but ad- vocate a major change involving Inter vivos intersponsal transfers. The gift tax marital deduction, unlike the estate tax deduction, does not permit a 100 percent deduction for up to 50 percent of the estate. The gift taxpayer gets a deduction for 50 percent of the actual amount given to his spouse. This requires the filing of returns for relatively small gifts, a requirement that Is frequently ignored, 1~a ding to disrespect for the law on the part of many people and imposing onerouS filing and payment requirements on the conscientious and well-adrised taxpayers. We believe that the same policies that led to adoption of the section 2515 exemption from the gift tax of the creation of a tenancy by the entirety or a joint tenancy with right of survirorship between husband and wife in real estate (in the absence of an eiectton) should be expanded to many other interspousal transfers made Inter vivos. Section 2515 should be extended so that all trans- fers into joint ownership, InCluding community property transfers, by either spOuse, regardless of the source of the funds, would be treated as exempt unless the spouses elected to have them treated as completed transfers. Thus, the um- brella of section 2515, now limited to real estate, should be extended to stocks, bonds, savings accounts, and all other types of property. Even tenancies in com~ men should fall into this shelter, since the tendency of people in creating all of thbse joint interests ~s to give half of an aggregate amount, so that such a rule would reali~ rather closely, parallel the pZ'esent policy on joint tenancy. Under existIng p$vlsions of Section 2515, terminatIon of a real estate joint tenanCy between spoh~es or a real estate tenancy by the entireties may or may not r~sult in a gIft, ~iependiug on the ratio of original contrIbutions ataj the PAGENO="0730" 716 property interests acquired. This is frequently the occasion for an inadvertent gift. Extension of section 2515 to all types of property, without any attention to the inadvertent gift problem would exacerbate the existing problems Of non- compliance in this area. As an inducement to taxpayer awareness and com- pliance, a new type of taxpayer election in this area is suggested below. Unawareness is the real reason that many transfers into interspousal co- ownership form are not coupled with elections to treat the transfer to the non- contributing spouse as a gift. Existing section 2515 requirements requiring the election to be made on a timely return operate as a trap, for when the couple finally becomes aware of the possibility that the transfer might have been a gift, it is almost always too late for a timely return. To constitute the noncon- tributing spouse as an owner then would require a gift of the entire one-half interest. Appreciation and inflation aggravate the problem since current fair market value would be involved in a transfer at termination of the joint interest. If that value is higher, and if the termination would involve a transfer of an asset acquired by gradual payments over a period of time, the gift tax conse- quences can be very severe. As an example, consider a house bought with a purchase price of $50,000 and a $10,000 down payment. Mortgage payments in annual increments are made. Had elections been made on timely gift tax returns to treat the down payment and annual mortgage payments as gifts, little if any gift tax would be paid. On the other hand, if the elections are not made and if a severance is effected on a sale with each spouse receiving one-half of the proceeds and the appreciated value is $150,000, the consequence is a $75,000 gift (subject to the gift tax marital deduction) by the contributing spouse to the noncontributing spouse'. This can be very disadvantageous in many situations. A relatively simple statutory change to permit the election to be made on a return, whether timely or not, would relieve the situation. It is particularly pertinent if the suggested section 2515 change is made, for nonrealty transfers are virtually handled in this fashion now. Acquisition of a security in joint form under existing law involves' a gift. The tax now remains due, based on fair mar- ket value at acquisition, under today's law, and can and should be paid on a return, whether timely or not. The taxable event was acquisition, and not any- thing subsequent. What is being urged here for an expanded section 2515 is that acquisition remain the `taxable event, with the election available to treat the transfer as a gift at any time after acquisition. In essence, the question of gift or no gift would remain open until the spouses close the transaction, but, when It is closed, the closure would relate back to acquisition cost and would not re- quire a fair market value transfer at the date of closure. 2. Joint property at death Section 2040 should be amended so that at death only half of the property held in any form of joint ownership would be taxed in `the estate of each spouse, without tracing. But any property held in joint ownership for which no gift tax has been paid at creation should be removed from the adjusted gross estate in figuring the base on which the maximum marital deduction (50 percent of the ad.justed gross estate) is computed at death. This is the present approach to' community property. 3. Jthrtension of the credit for prior transfers If the donee-spouse dies first, half of the property will be included in her or his estate, and the entire property' will subsequently be included in the donor- spouse's estate. This is a problem that generally exists where gifts are made to a `spouse. It can be alleviated by an ex'tension of the existing credit for property previously taxed in the estate of one spouse, with the elimination of the present 10-year limit an'd the 20 percent credit decrease that occurs every 2 years. This specially extended credit rule for property previously taxed in interspousal transfers would permit a 100 percent undiminished credit, regardless of the num- ber of years between the deaths of the spouses. The unfortunate whipsaw consequences of the same property being included in the estates of two decedents (usually spouses) could be `~olved by ext~x~ing the mitigation of the statute of limitations provisions in sections 1311 through 1315 into the estate tax area. These provisions deal with inconsistent Income tax determinations that either give the government or the taxpayer an unfair advantage which cannot be rectified because of the running of the s'tatute of PAGENO="0731" 717 limitations. The provisions permit the reopening of the statute of limitations under certain conditions In the interest of fairness. However, they are quite eomplex and the extension of them to the Federal estate tax will add further complexity to them. We believe that the same objective can be accomplished through the use of the :above~described 100 percent credit for tax on prior trans- fers between spouses. 4. Qualitative evpansion of the marital de.Zuction and elimination of the ter- minable interest rule With respect to the qualitative aspects of the marital deduction, we favor qualifying for the marital deduction any full income interest passing to the sur- viving spouse, regardless of whether there is a general power of appointment accompanying it. Thus, deductibility would be given in the first estate, provided that the interest is to be included In the second one~ Furthermore, the surviving spouse should be allowed either to accept or reject the marital deduction tax result in the qualifying limited interest situation, such as where be or she re- ceives only a life estate. Thus, in effect, the surviving spouse would have an option to prepay the death taxes when there is a straight life estate, but still receive the life estate. In essence, the section 2050 terminable Interest rule would be abolished in the interest of simplicity, to make it easier for the nonspecialist to avoid problems and to avoid the whipsaw effect of the inconsistency involved in requiring inclu- sion in the survivor's estate in situations where the martial deduction is not always available in the estate of `the first spouse'. This is illustrated `by. cases involving overly broad powers to allocate between principal and Income or to retain unproductive assets, so that not all the Income requirements for a marital deduction power of appointment trust are met and cases where the power of appointment d'oes not qualify as a general power of appointment under section 2050 Jut nonetheless falls within the section 2041 definition of a general power of appointment. Another example of cases which would be ameliorated by this change are those where there is disallowance of the deduction in the first estate because of a requirement of survivo'rship running beyond the allowable 0-month period which actually is satisfied so that the property does in fact pass to the surviving spouse andis taxed in the second estate. Perhaps the worst aspect of the present requirements Is the compulsion they place upon a property owner. He must do something with his property that be might not otherwise wish to' do. While be may be perfectly willing to' provide for his spouse, be may not want to do this In a way th'at allows that spouse to divert *the property from bi~ children after his death. These fears may involve a fear of the surviving spouse's remarriage or where a donor has a family by a pre- deceased first spouse `and then reunarries, fear that `the second spouse will not make the adequate provision for the children of the first marriage. To mitigate this ~ltuation, we propose amendments to section 2056 that would permit a lim- ited interest to qualify for the marital deth~ction. If the decedent's spouse leaves the surviving spouse an interest which will cause the property to be inducible in the survivor's estate upon death, that fact alone ought to be sufficient for a qualifying gift, If the survivor accepts broad benefits, such as~ a general power of appointment or outright ownership of the property, then of course the first estate is allowed a deduction, because the survivor has that quantum of ou~nership which requires estate taxation when he or she later dies. That rathe~ parallels the present marital deduction, except that it substitutes for the technical termintible interest rules a basic rule which simply and directly states that the Interest qualifies if the surviving spouse ,takes such an interest a~ would cause inclusion In the surviving spouse's estate if retained until dèlLth (which, of course, also means that, if the survivor disposes of it before death, it is subject to the gift tax). A further reCQmmendation is that the spouse dying first should be able to tender to the `second spoftse a terminable interest which qualifies, if the first spouse to die de~1ares a desire to have that interert' 4uali~y. Thus, In the classic case of a life estate for the wife, with remainder oyer towbomevOr her husband directs, if the widow accepts this tender, it should be deductible in her husband's estate and her acceptance of it as `a marital ded~ictlon gift will constiti~te a stipu- lation that it will be includible In her estate when she later dies. ~nless,her husband expressly conditions this bequest oil `her acceptance of it as a marital deduction bequest, however, she could take the property rights but decline the PAGENO="0732" 718 tax consequences through post mortem planning, and prepay the tax by declin- ing to take it as a marital deduction gift. She could still have the right to the Income (she need not forfeit her rights under the Will) but she only declines to take it as a marital deduction gift. Protection of the husband's other beheficiaries is important in such a situa- tion. This could be accomplished by having the additional tax caused by this unanticipated enlargement of his taxable estate borne specifically by the assets which caused that enlargement, that is, the assets tendered but rejected for the marital deduction. Of course, the husband may include an apportionment clause to the contrary, but sections similar to the tax apportionment for life insurance under 2200 and powers of appointment under 2207 should be put in the Code to deal with the unplanned situations. These proposed changes should not cause a significant loss of revenue, but would give much more flexibility to estate planning, particularly at the post mortem stage; the election could actually result in particular cases in revenue advantages because of the prepayment of taxes that would otherwise not be due until the wife's death. This election, however, would most likely be used in cases Where it would be advantageous from a rate viewpoint. In any event, where it does reduce the tax, it does so by removing an inequity rather than creating one. D. RAISE TH5 EXEMPTION TO $100,000 AND CHANGE IT TO A CREDIT Another problem that is receiving considerable attention lately Is the debate over whether the Federal estate tax exemption should be increased, in ~riew of inflation. We are concerned over the estimated $2 billion revenue loss that an Increase in exemption to $1~0,000 would appear to create. We believe that many of the problems caused by inflation pushing far more people into the Federal estate tax brackets will be solved by adoption of the liquidity proposals we have previously made. We also recognize that some allowance must be made for in- flatioti, that complete relief from the estate tax and the filing requirements is desirable in similar estates. However, we believe the revenue impact of this relief must be held down by changing the exemption to a credit. We also recognize that if there is a material increase in the estate tax ex- emptions, questions of fundamental social reform, rather than narrow tax reform, are raised because, If a tremendous tax loss results from exempting so many modest-sized estates that are now subject to tax, It may be necessary to make up that difference by accelerating rates (if the estate tax is to continue to produce the same amount of revenue) and, inevitably, even without a conscious and independent policy decision, a rate structure might then be adopted which would tend to break up even moderate concentrations of wealth and deter needed capital formation. This is not the sort of result that should be reached as an incidental part of estate tax revision, but, to some extent, it would be a byproduct of raising the exemption (unless the exemption can be raised in the context of other revenue increases). It would be most desirable to exempt the many estates which involve only modest amounts of wealth being passed to a spouse or children where both planning and administration are now complicated and little revenue is pro- duced, Accordingly, to the extent consistent with revenue considerations, we recommend that many estates be exempted from the Federal estate tax where neither the returns nor the administration and planning are worth the effort. We suggest that this be accomplished by means of a credit, rather than an exemption. This credit could be used, in effect, to increase the $60,000 exemp- tion to $100,000 by taking the amounts from the bottom rather than the top (eliminating tax on the small estates, but giving the relief in the large estates at the bottom, rather than at the top rate). We propose that in lieu of the present $60,000 exemption ($120,000 for trans- fers qualifying for the marital deduction), a credit against the tax due on the first $100,000 of taxable estate ($200,000 in the case of transfers qualifying for the marital deduction) be permitted. This credit should be designed so that gross estates of $100,000 or less need not file returns. This latter point is of the utmost urgency, since if it is not done, the change will cause further unneces- sary con~plications and costs in the administration of small estates. Ii, VALUATION Turning to the question of valuation of assets, wherever there are closely held business interests or hard to value tangibles, estates are put to a consider- PAGENO="0733" 719 able amount of a~ditional expense and both the e~tate and ~the Government spend quite a bit. of timq and money in valuation proceedings, W.e believe that the settlement of estates could be facilitated by improvement of the present valuation methods. For example, section 2081 presently requires that unlisted and untraded securities have their values determined by considering, along with all other factors, the value of securities of corporations engaged in similar ilnes of businesses which are listed on an exchange. The limitation of this coin- pariso~ to corporations whose securities are listed on an exchange is a technical defect in the law. Accordingly, section 2031 should be amended to permit com- parisons with the securities of other corporations engaged in the same or a sim~ ilar line ~f business, regardless of whether their securities are listed on an exchange. Under Regulations promulgated pursuant to section 2031, tangible personal property is valued at the price at which an item or comparable item could be obtained in the retail market. Thus, replacement value is the criterion for valua- tion rather than the price obtainable in the market or markets available for the holder of the property being valued. This approach of the Service was rejected by the United States Supreme Court in the Uartwr4jht ease, decided in 1973, which involved the valuation of shares of an opeli-end mutual fund. The price obtainable by the executor or donor in whatever markets are available to him is a fairer measure of value. Accordingly, we recommend amendment of sections 2031 and 2512 (gift tax) to provide that tangible personal property be valued for estate and gift tax purposes at the price obtainable by the executor or donor in the market or mar- kets available to him. If this proposal is coupled with the previously made one permitting an election of a delayed,valuation date for hard to value assets, many of the valuation disputes that now occur would be avoided and the large expense incurred by estates possessing closely held businesse~ in obtaining appraisals of them for tax purposes could also be reduced, if not entirely eliminated in a large number of cases. F. GIFT TAX FILING There are two other areas of the estate and gift tax laws which are wide- spread in their effect where the present rules create both unnecessary complex- ity and inequities. The first of these deals with the gift tax filing requirements. The Excise, Estate and Gift Tax Adjustment Act of 19T0 required for the first time that taxable gifts be reported quarterly, rather than annually as provided by prior law. This: quarterly filing requirement has proven to be a major adminis- trative inconvenience to the Internal Revenue Service and constitutes a costly nuisance to individuals who make relatively small taxable gifts in several quar- ters. The extra work. required by the quarterly filing requirements may In many in~tanees be far more costly than the relatively small value derived by the Treas- ury from a slight acceleration of gift tax revenue. We recommend a prospective return to annual filing,, at least for most donors. Only where an thdividuaVs gifts in one calendar quarter aggregates $100,000 should an individual still be required to file a quarterly preliminary gift tax return with respect to that calendar quarter. This amount appears to be a reason~ able figure which would eliminate most quarterly returns without `deferring the payment of any substantial amount of gift tax. EIghty-five percent of the persons filing gift tax returns would not have to file quarterly preliminar~~ gift tax re- turns, yet 7~ percent of the total gift tax paid for the year would be reported and paid with the preliminary gift tax returns. Where quarterly preliminary gift tax returns are in fact required, gifts be- tween spouses should be permitted to be split on a preliminary basis, with a nonbinding election until the subsequent filing of a final return for the calendar year. At that time the spouses could elect to split their gifts or not split them, regardless of the election made in the preliminary quarterly returns. Similarly, the election te treat acquisition by spouses of a joint interest in an~ property as a gift would be made in the annual gift tax return rather than In the preliminary quarterly returns. G. nS1~ATF TAX CREDIT FOB GIFT TAX PAIfl We recommend that section ~0i2 be amended so that in computing the limita- tion on the estate tax credit allowed for gift taxes paid iii respect of property in- cluded in the decedent's gross estate, the estate tax attributable to such property should equal the reduction in ~estate tax if such property were removed from PAGENO="0734" 720 the gross estateS At present, the estate tax credit for gift tax paid in respect of property included in a decedent's gross estate for estate tax purposes is limited to the lesser of the gift tax paid or the estate tax allocable to the gift. Those limitations are computed under present law by a complicated method involving the average gift tax rate and the average estate tax rate. Substitution of the highest applicable bracket rates for the average rates determined under present law would greatly simplify the computation of the credit and would reduce the number of cases in which the credit i~ partially lost by application of the limitations. Thus, we recommend that the computation used to determine the amount of gift and estate taxes allocable to property subject to both taxes for purposes of the limitations be changed to reflect the incremental amounts of gift tax and estate tax attributable to the doubly taxed property. H. THE STATE DEATH CREDIT In the written statement submitted on behalf of the College by President Cant. well, he indicated that we were working on a state-by-state analysis of the economic effect of the state death credit and would submit a report, which we expected would be ready within a month, to your Committee for its considera- tion in connection with your deliberations. It is now apparent that this report, which we had hoped to attach to or make a part of this supplementary statement was not as far along as we had believed in March. Therefore, it will not be ready for several more months. When it does become available, we will submit its results, together with recommendations for a closet integration of the state and federal death tax systems, based upon some form of incentives given the States to conform their death taxes to the federal estate tax, to this Committee. I. EFFECTIVE DATES OF TAX CHANGES Our final recommendation deals with effective dates of any and all changes that may be made to the estate and gift tax laws. We believe that all such changes should apply prospectively and not be applicable to any past transfers. The effective dates should be such as to allow a reasonable period for amendment of existing estate plans. If major structural changes (such as new taxes on gen- eration-skipping transfers, an unlimited marital deduction, some form of taxation of appreciated property at death, a radical change in the entire death tax system by bringing in an accessions or an inheritance type of death tax or the unification of the estate and gift tax or substitution of a capital transfer tax for it) are made, we believe that an extensive period of time should be permitted for the transition to occur, in the Interest of stability. The general policy of amending tax laws only prospectively should be strictly observed in estate and gift tax revisions. Obviously, many gifts have been made and many trusts established on the basis of the present tax system and its rules, which have remained substantially unchanged since 1951. Fairness requires that significant changes not be applied to the detriment of those who relied on exist- ing law. Specifically, if Congress decide:s to unify the estate and gift tax system or substitute for it a capital transfer tax, similar to that used in England, it is imoprtant, as the proposals to date have generally contemplated, that there should be a "fresh" start, with a single lifetime exemption available in full with- out regard to prior gifts, and without including prior gifts in computing the tax on future transfers. Similarly, if a switch to an accessions tax is made, there should be no attempt to compute and charge recipients of gifts and inheritances with any of these received prior to the effective date of the new law. If a tax is to be imposed at death on appreciation (either a capital gains tax or an additional estate tax), or if there is to be a carryover basis, we believe that a new basis date should be provided, in order to avoid inequities caused by failure in the past to keep adequate records (which taxpayers could legiti- mately have considered unnecessary) similar in concept (if not in purpose) to the March 1, 1913, value used for Income tax purposes, after adoption of the Sixteenth Amendment to the Federal Constitution. If generation-skipping transfers are to be specifically taxed, the new tax rules should apply only to transfers made after the effective date. Irrevocable trusts created prior thereto, whether during the settlor's lifetime or as a result of his death, should have their dispositions exempt from these new rules. Finally, there should be a reasonable grace period for amending wills (and revocable or otherwise amendable trusts), similar to that provided in connec- PAGENO="0735" 721 tion with other estate and gift tax amendments that have caused major changes in the past, to allow a review of estate plans by all taxpayers and their advisers. This grace period should run for at least five years, since experience has shown that even relatively minor changes in the past have required extension of orig- inally granted two~year grace periods (witness what occurred to the changes in the charitable remainder trust rules and the transitional rules designed to deal with problems caused by these changes under the 10k39 Tax Reform Act). The above proposals are those of a duly authorized Committee of The Amer- ican College of Probate Counsel, created by the College's Board of Regents and appointed by President William P. Cantwell, of Denver, Colorado. The Com- mittee consists of the following lawyers: Frank S. Berall, Chairman, of Hartford, Connecticut; Luther. J. Avery, of San Francisco, California; Joseph Kartiganer, of New York, New York; Arthur Peter, Jr., of Washington, D.C.; Raymond A. Reister, of Minneapolis, Minnesota; and B. Frederick Velikanje, of Yakima, Washington. Mr. BUnx~EsoN. Mr. Sutherland. STAThMENT OP WILLIAM A. SUTHERLAND Mr. SUTHERLAND. Mr. Chairman, I thank you for the opportunity of being here. I have a very simple suggestion, a little different from the last one that Ihad before this committee. I was chairman of the tax section of the American Bar Association in 1948 when the committee that I had appointed of common law and community estate lawyers worked out the split estate and gift tax system which we now have. It was a long step forward toward equity in the country, and I don't have any proposal now that is so earth- shaking as that one. With the small suggestion I have, I probably shouldn't have asked to appear, but I am greatly impressed with the necessity of simplifying the tax laws and eliminating to the extent possible what taxes have to do with the way people live. I think there ought to be an unlimited right of spouses to transfer property at death or during life from one to the other without any tax considerations at all. I trust that the committee will quickly con- sider the possibility of so providing, without delaying to consider small exceptions to that provision which, over time, you may possibly find to be desirable. I think it a pity that husbands and wives who al- most never keep accurate records, if any at all, of transactions between themselves should be required to have their taxes based upon records which are not complete and never will be. If there were permitted an unlimited right of transfer between spouseS, without tax, I do not believe there would be any substantial loss of revenue. If a husband or wife is foolish enough to transfer to the other spouse the larger portion of the total family property, it will be in the estate of the transferee; and if a spouse were that thoughtless, there would probably be more taxes collected by the Government. I personally believe that the tax effect would be very small and, if the tax effect is such that the committee should feel that the decrease in taxes should be made up in some other way, I believe a very small increase in rates would be sufficient to offset the loss. That would be much more de~irab1e than requiring husbands and wives to keep rec- ords of transactions with each other. My partn~r, Mr. Williams, in the 25th annual New York Institute, in discussing the desirability of unlimited gifts and transfers at death between husband and wife without tax, said: PAGENO="0736" 722 These sweeping changes would accept, for tax purposes, the common view that property of the husband or wife is "our property~'. without regard to the legalistic niceties of title holding, would take spouses out of the bookkeeping business inter sese to the extent they chose, would provide considerable simplification of the ~rbole area, and would much more surely equate the transfer-tax treatment of common law property and community property. I see nothing whatever to militate against making this change im- mediately without waiting to determine what tax-significant changes you may wish to make in the estate and gift tax law. Since this is so simple, I don't see why it should have to wait upon the decisions you make as to the serious and tax-significant problems thdt Mr. Cantwell and others on this panel propose to the committee. I am not speaking against their proposals. I only want to urge that the simple change which I propose can safely be made without delay. It may be that there ai~e other provisions in the tax laws that are this simple, the elimination of which would take a great deal of com- plexity ou~ of living. If such provisions can be located and if their elimination would have no more effect on the tax receipts than would my suggestion, I would hope that the committee may find other areas in which it can quickly effect simplicity without waiting to decide upon proposed changes involving important issues of substantive tax policy which properly deserve extended consideration and debate. Thank you again. Mr. BtTRLESON. We will hear from you, Mr. McGinty. STATEMENT OP EDWARD Mc~I~TY, ESQ. Mr. McGINTY. Mr. Chairman, members of the committee, I am delighted to be here today to discuss with you the issues before the committee during the course of these hearings. I have a written statement which I have submitted which is much broader and much more detailed than my verbal remarhs can possibly be here today. I would request that it be included verbatim in the record. Mr. BUItLESON. Your full statement will be included in the record, and you may proceed. Mr. MOGINTY. Thank you, Mr. Chairman. I believe that the course of these hearings and the prior record have demonstrated to the satisfaction of nearly eveiyone that the present estate tax law is indeed compelling the sale. of farms and ranch land and open-space land and, further that when such land is sold at higher valuations than can possibly be sustained for agricultural purposes, such lands are being converted to commercial, industrial, and residen- tial uses, which are much more intensive than agricultural uses. And further, that when such lands are so converted, they are irrevocably lost to agriculture because the process seems to be irreversible, that is, it is impractical and uneconomical to attempt to raze the buildings that have been constructed on the lands and return the lands to agri- cultural production. Further, that the continued transfer of such lands will ultimately result at some point in time in a situation where this country is unable to produce an adequate amount of food for our needs and that such a shortage will have much more serious consequences than we have been faced with so far in the oil shortage. PAGENO="0737" 723 Mr. Brannon's comment yesterday stirprisecl. m~ to~ the extent that he said that he was not concerned about the conirersio~of agricultural lands to more intensive uses. It seems to me that this demonstrates that he really doesn't understand the problem~ and I wonder how he will feel if at some time in the future he has nothing, i~ft to eat but his own words. It seems to me that the problem ~s adequately defined and recognized and that it is a serious threat to the public interest. This brings us to the problem, really, of how do we solve the problem rather than whether or not a problem exists. In this regard, it sems to me that the real central isstie~facing us is the design of legislation to effectuate the necessary estate tax relief to allow these families to continue to own their farms and ranches in successive generations and, at the same time, not open the door to abuse of such legislation by other persons who are really not interested in the preservation of such lands, but who would only enter into invest- ments in such lands for the purpose of lowering the estate tax on their estates when they attempt to pass them on to their heirs. The way, it seems to me, to accomplish this is ~ simply design the legislation so that it is discouraging to those who would use it to abuse the purpose of the legislation. I would s~thmit to you that there are ihree provisions whixth, if written into this type of legislation, should be effective to foreclose the possibility that there would be any extensive amount of abuse. These three provisions are that the legislation should provide that the decedent must have either inherited his interest in such lands or owned such interest for 5 years prior to his death; two, that the special valuation under the legislation would be de1~ermined as the higher of either the value for the qualified use, that is agricultural use, or the adjusted basis of the land in the hands of the decedent im- mediately prior to his death, that is, what he paid for the land, has invested in it, less whatever depreciation he may have on improvements in the land and, finally, to stretch out fhe~, ~eri~d of recapture and gradually phase out. recapture rather than ab~uptly~ ph 4t out or abruptly terminate it, perhaps stretching it from 5 years as in most of the current bills, to perhap~ 10 or even 15 years would also haste `the effect of reducing the possibility of abuse. Let me explain how each of these would fUnction to foreclose the abusive possibilities. First, virtually no one can predict that they will live for at least 5 more years but not much longer. Therefore, the first `provision would mean that, if someone were attempting to use the' provisions of the legislation as a temporary investment in such lândsl to pass on their estate at greatly reduced estate ta*es, they would be taking the risk that, No. 1, they would die"~rior to ~having owned it for 5 years, in which case they would not have the benefit of the election, and they would have made their estate'iiliquid and very dMlcuit for `their heirs and administrators to manage, and No. 2, if in fact they live much longer, 20 or 25 more years, then in their late years they would have red~iced the amount of income they; are, getting from their investment.s at the same time their earning~ years are essentially over, and when they need such income to live appropriately. So I believe, or at least I know from i~i~ `present clients, tilat they would not be interested in taking such a gamble. 68-872--76----47 PAGENO="0738" 724 The second provision that the special valuation will be the higher of either the qualified use value or the adjusted basis of the land in the hands of the decedent before his death would foreclose this pos- sibility in the following manner: If a person invests in such land in * the late years of his life, then he is going to have to pay fair market value for that land, and when he dies, he is not going to be able to obtain the agricultural use valuation but he is going to be stuck with the fair market value which he paid and, therefore, the legislation is going to be alot less attractive for that type of investor. Finally, if we can stretch out the period of recapture from 5 years, as in most of the current bills, to 10 or perhaps 15 years, and begin to phase it out gradually after the first 5 years, say reducing it by 10 percent a year for the 10 years after the first five years, then we will eliminate the tendency of heirs to want to encourage executors to avail themselves of this legislation solely for the purpose of getting lower estate taxes and then, as soon as the period of recapture has expired, to sell the land to a developer, because you are looking at a 15-year period, and most Americans are just not willing to hold onto an illiquid low-income investment for that long a period of time. We Americans want to see our investments realized in a relatively short period of time, usually within a 5-year period or less. I think that if these three types of provisions are incorporated into legislation to resolve this problem that we will largely eliminate the possibility of its being abused by the types of individuals about whom concern has been expressed today and yesterday during these hearings. That concludes my remarks, Mr. Chairman. Mr. BVRISSON. Thank you, Mr. McGinty. Mr. MCGINTY. Thank you, Mr. Chairman. [The prepared statement follows:] SPATEMENT or A. EDWARD McGINTY, TAMPA, FLA. The purpose of my testimony is to discuss the major reasons why certain proposed legislation should be enacted to effect changes to the estate tax pro- visions of the Internal Revenue Code of 1954 to provide for a method of valuation, for estate tax purposes, of farm land and other agricultural lands and open spaces which would be lower than "fair market value" as presently required. In recent years, much has been said and ~vritten about the continuing decline in acreage devoted to the production of food and to continued existence as open space or greenbelt. The preservation of such productive argicultural lands and open spaces has been much touted as a national goal to which the efforts of various federal and state agencies, as well as a number of non-governmental organizations, are devoted. I do not have the statistics presently available to me to document the extent of this problem. However, I am sure that the Department of Agriculture and other concerned federal agencies can provide some data in this regard. As a lawyer in Tampa, Florida, practicing in the fields of tax and estate law, and having represented clients in the real estate development and agricultural fields, I do know that agricultural and open space land is indeed being converted to more intensive uses. TIlE TJItGENT NEED FOR FEDERAL ESTATE TAX RELIEF FOR AGRICULTURAL AND OPEN SPACE LANDS One of the factors contributing, unwittingly, I believe, to the continuing conversion of agricultural and open space lands to more intensive uses is the federal estate tax. Why? While the federal estate tax rate structure (which is a progressive rate, rising from 8% to 77% as the value of the estate increases) and the "fair market value" system of valuation for federal estate tax purposes PAGENO="0739" Estate tax ~ Taxable +t~f'~ Federal ~ Estate `~`~`~ Taxable ~ 725 are generally fair and desirable, complex tax and regulatory laws can produce unfair and undesirable results as applied to specific types of situations when changing circumstances have precipitated nnforeseeable results. Just such a situation has occurred with respect to a large amount of the nation's agricultural lands arid open spaces. Much of this land Is located near cities and towns, resorts, major government and industrial installations or simply In a beautiful area with a good climate, such as my home state of Florida. Consequently, such land has become pre~sently or potentially suseeptable to more intensive uses, such as conk merical, Industrial or residential, which yield a much greater return on Invested capital. There Is a fixed supply of land, and as more and more of it Is developed, there is less of it available for present and future development. For these reasons, such land is aggressively sought by those persons and companies who make their living developing and using developed land. The developers and speculators bid up the "fair market value" of the land. "Fair market value" means the dollar amount that a willing buyer will pay to a willing seller for the asset (See news articles by David A. Andelman In the New York Times of May 14, 1972, by Gall Bronson In the Wall Street Journal of May 15, 1974, by Michael Burns In the Baltimore Sun of May 19, 1974, by Isaac Rehert in the Baltimore Sun of February 19, 1974 and by Steven Norwits in the Baltimore News American, all of which were made a part of the Congressional Record, 94th Congress, January 15, 1975, Vol. 121, `No. 2 and which are attached to this statement for convenience of reference.) A two-tire valuation Is thus created for the same parcel of land, a low-tier value for agricultural and open- space uses and a hi'gh~tler value for the more intensive uses of our industrialised society. This two-tier valuation problem literally forces the family of a deceased farmer to sell the farm to a developer, speculator or other Intensive `land user. Let me give you an example: Assume a farmer owns an 800 acre farm which earns him about $30,000 per year, averaging the good and had years, At strictly farm prices, his farm may be worth, say $300 per acre or $240,000. In addition to this asset, he has a home on the farm worth $35,000, $50,000 In farm machinery, $6,000 worth of cars and trucks, $15,000 in savings, $5,000 in miscellaneous personal assets and a `$50,000 life Insurance policy with $5,000 cash surrender value, If we assuin~ that he has no debts, our farmer has a gross estate value of $4cY6~O00, Upori his death his estate tax picture will work out about as follows: Gross Estate.. $406, 000 Administrative expenses -~5, 000 Leaving (adjusted gross estate) 401, ooo Maximum marital deduction (assuming he is Survived by his wife)._ `-200, 500 200,500 -~- - -60, 000 - 140, 500 $32,850 The deceased farmer's family can afford to pay estate taxes of $32,850 and continue to own and operate the farm. Now, let's assume that the farmer's 800 acre farm is situated so as to `be well-suited for a major community development. The fair market value Of such land may well be in the neighborhood of $8,000 per acre or $2,400,000 for the 800 acres. Re now has `a gross estate value for federal estate tax purposes of $2,516,000. Gross Estate $2, 516, 0o~ Administrative expenses -5,000 Leai'ing (adjusted gross estath) 2,511,000 Maximum marital deduction (assuming he Is survived by his wife) ~_-1, 255,500 25 -60, 000 $1,195,500 $403, 750 Federal estate ~" PAGENO="0740" 726 The deceased farmer's family cannot pay $400,000 in estate taxes except by selling the farm to a developer .or speculator. This example is typical of the classic farm family problem, of low liquidity and high land values with concommitantly high estate taxes. How many times can this scenario be repeated before our agricultural production is inadequate to provide enough food for domestic production and to require us to import food to survive, as we now import oil to survive? What are the economic, political, ecological and social implications if the continuing loss of agricultural and open space lands is not halted? It has been said that our farmers are wealthy. But the sad fact of the matter in most cases, as in the example I have used, is that the farmer is only wealthy if be sells the land to a more intensive user. Do we want him to sell his land to more intensive users? We are forcing him to do so now through the estate tax. The purpose of the proposed legislation, as illustrated by the various bills that have been filed to effect a lower valuation than "fair matket value" for agri- cultural and open space lands, is to change the estate tax law to ~nake it possible for the survivors of deceased agricultural and open space land owners to bold onto the land and continue to use it for the production of food, other agricultural commodities and greenbelt purposes. Why is such estate tax relief necessary only for farmers and ranchers and open space land owners? Would not such estate tax relief discriminate against heirs of other property, such as a family business? The answer is that the problem is unique to the owners of farm and ranch land and open spac~ land. The "fair market value" of a going business, is generally determined by capital- izing the earnings of the business. This is because the buyer of a going business is interested in how much be can earn from the business rather than how much he can make by terminating the business and selling off the assets or converting the business to a different or more intensive use. When estate taxes are based upon values determined by capitalization of earnings, the resulting taxes will be an amount which can be amortized from the earnings of the business, so it will not be necessary to sell the business to pay the estate taxes. The proposed legis- lation seeks to apply to the owners of farm, ranch and open space lands, a valuation determined by capitalization of earnings or some other equitable method of determining value on the basis of the continuing use of such property for farming, ranching or open spaces. TECHNICAL ASPECTS OF THE PROPOSED LEGISLATTON I do not have the time in this statement to go into all of the technical aspects of the proposed legislation. But I do want to make some comments concerning certain technical aspects of legislation addressed to the resolution of the estate tax problem of agricultural and open space land. ESTATE TAX CREDIT OR ALTERNATIVE METITOD OF VALUATION There are two methods to effectuate a change to the Internal Revenue Code of 1954 (hereinafter the "Code") to provide an alternative method of valuing a~ri- cultural and open space lands for federal estate tax purposes. Most of the hills that have been filed would create a new subsection to Section 2031 of the Code providing an election for estates with qualifying property to value the land at its value according to its qualifying use. At least one bill, Senator Stone's bill, S. 2267, would create a new section of the Code, Section 2017, which would pro- vide an elective estate tax credit for estates with qualifying property equal to the difference between the estate tax on the faIr market value of qualifying property and the estate tax on the value of such land according to lts qualifying use (see also the attached proposed bill which we have prepared). Either method produces the exact same formula for determining the va1ue for federal estate tax purposes so that the amount of estate taxes payable would be the same under either method. We prefer the latter method, the tax credit method, however, for technical rea- sons. It is important that the fair market value be finally determined at the time the estate tax return is accepted because the amount of deferred estate taxes sub- ject to future payment under the recapture provisions is determined by the fair market value at the time of the decedent's death or on the alternate valuation date. The amount of estate taxes due should not be affected by appreciation or PAGENO="0741" 727 &~pred1h~tion in the value of qualifying property* subsequent to the estate tax value determination date. In the event of the inability of an estate and the Internal Revenue Service to settle any differences of opinion concerning the fair market value of qualifying property subject to the election, it would be necessary for a court to decide the matter. In the case of the first method of effectuating this change, the addition of a new subsection to Section 2031 of the Code, we are concerned that the federal courts may determine that the question does not present a justiciable controversy at the time the returfi is accepted because the question of fair market value would not affect the amount of estate taxes payable at that time but would only affect a contingent future controVersy in the event of recapture, an event that may never occur. See Golden v. Zwickler, 394 U.S. 103 (1969) ; Toilet Good8 Ass'n v. Gardner, 387 U.S. 136 (1967). Under the secopd method, howev~r, in which the adjusted valuation is determined through the device of an estate tax credit equal to the difference between the estate tax on the fair marketvaluè and the estate tax on the qualifying use value, a justiciable controversy clearly exists because it is necessary to determine both the fair market value and the qualifying use value in order to determine the amount of estate taxes to be returned at the time of filing the estate tax return itself. WHAT KIND OF INTEREST IN QUALIFIED REAL ~norunr~ WILL QUALIFY FOR TEE ELECTION? None of the bills that we have read define the kinds of interest In qualified real property that will qualify for the favorable qualifying use values. Fnr example, it is not clear under these bills that the corporate shares of stock in an incorporated family farm would qualify, or that a partnership interest in a family farm or a beneficial interest in a living trust would qualify. Since the family corporation, family partnership and family trust are methods that have been used for niany yeai~s for family ownership of farms and ranches, it should be clearly provh~ed that such interests in qualified real property will qualify for the election. We have prepared a proposed bill with a provision that satisfac- torily resolves this matter, and we recommend that the provision be included in the Committee bill (see attached proposed bill). ROW IS THE VALUE OF LAND TO BE DETERMINuD ACCORDING TO ITS QUALIFYING USE? Senator McGovern's bill, S. 2875, is the only bill which provides a specific valuation formula for determining the qualifying use value. We have used this formula to compute acreage values in several hypothetical cases with results very close to current estimated agricultural values. We find Senator McGovern's valuation formula preferable to leaving the question of how the qualified use value should be determined to the Internal Revenue Service, the taxpayers and the . courts. Accordingly, we recommend the valuation formula contained in S. 2875. THE RECAPTURE PROVISIONS At least two of the bills that have been filed, S. 2267 and S. 80, provide for perpetual recapture, S. 2267 with perpetual interest accruing and 5. 80 with interest accruing only for the first 10 years. We are opposed to a provision for recapture in perpetuity. With recapture accruing in successive generations, the total amount of recapture, especially with continually accruing interest, could conceivably ~qual or even exceed the fair market value of the land after two or three generations. Perpetual recapture would also largely destroy the ability of the farmer and rancher to finance the business by borrowing, which Is essential to modern farm operation requiring large capital investment in machinery and buildings, as well a~ large periodic investments in fertilizer, seed, feed, et cetera. If the land will always be subject to a lien, in an Increasing amount, which is prior in dignity. to any lien a bank may place upon the land as security for loans it may make for farm improvements or for the pfircbase of farm equipment or Supplies, most banks will refuse to ~make any loan. National Banks will not make second mortgage loans and very few state. banks will make second mortgage leans. Inability to properly finance farm operations will result in lower crop yields which means, a smaller food Supply for tlienation and inad~quate income for th~ farmer to sustain his farm business and family. ., , PAGENO="0742" 728 Perpetual recapture would certainly cause serious administrative problems for the Internal Revenue Service, as well as for the heir and his heirs. The books could never be closed. Finally, the combination of successive generations and successive perpetual ~tax liens would play havoc with real estate titles. The other bills we have studied all provide for a recapture period of five years, hand we believe this to be a reasonable period of time. ~IIOW CAN WE PREVENT ABUSE OF THE ESTATE TAX ADVANTAGES OF TIlE PROPOSED LEGISLATION BY PERSONS NOT INTERESTED IN PRESERVATION QF AGRICULTURAL LAND AND OPEN SPACES BUT WHO DESIRE ONLY TO BUY AND HOLD S~JCR LAND TEMPO- ~UARILY AS A SHELTER FROM ESTATE TAXES? A law that would solve the estate tax problem of the farmer, rancher and owner of open space land without opening the door to extensive abuse by wealthy people seeking only a temporary depository to shelter substantial capital from the estate tax is the goal of many who understand the problem of high values, low liquidity and high estate taxes facing owners of agricultural land and open spaces. How is the goal to be achieved? What safeguards can be employed which would prevent abuse and, at the same time, eliminate the estate tax- compelled sale of farms, ranches and open spaces? Experience as a tax adviser and estate planner has taught me that this Is a relatively simple task. It is only necessary to discourage individuals who have no intrinsic interest in agricultural land and open spaces from purchasing such land to hold for the briefest possible time in order to shelter from full estate taxation the passage of substantial sums. to their heirs. Such discouragement can be effectively achieved in several ways without damaging the relief provided to the legitimate farmer, rancher and open space landowner. 1~1irst, all of the bills I have studied provide that in order to qualify for the special valuation treatment, the land must have been adopted to one of the qualified uses for a period of five consecutive years prior to the death of the decedent. Virtually no one can predict that he will live for at least five more years but not much longer. Thus, if the requirement were altered to provide that the decedent must have either inherited his interest in qualified real property or owned such interest for five years prior to his death, it would effectively frustrate the planning of an investment in qualified real peoperty solely as an estate tax shelter. If an individual buys such property and dies within the five year period, the favorable valuation Is unavailable, and he has destroyed the liquidity of his estate, creating very serious problems for his heirs. If he lives much longer than five years, he has tied up substantial capital in an illiquid, low yield investment during the non-earning years of life when he is likely to need, and want to enjoy, a good income from his investments. Thus, the provision that the election can only be made with respect to an interest in qualified real property which has either been inherited by or owned by the decedent for the five years immediately preceding his death should be adequate to prevent abusive employment of the election. However, a further step can be taken which should fully foreclose the possibility of abusive employment of the election. This can be very simply accomplished by providing that the value under the election shall be the higher of either the value of such land according to its qualified use or the adjusted basis of such land In the hands of the decedent immediately prior to his death. An example of such a provision is contained in our attached proposed bill. Such a provision would have the effect of making the valuation under the qualified use election little different than fair market value ~or short-time investors in such property who seek to gain an estate tax break and who believe they can accurately predict their death in five or six years. The combination of the two provisions described above should be sufficiently discouraging to foreclose abusive uses of the special valuation election without damaging the intended relief for legitimate agricultural and open space landowners. If, how- ever, still more protection is desired, say, to insure that the special valuation election is not used solely to gain a `tax break by heirs who have no intention of keeping the land, the recapture provisions could be gradually phased out over an extended period. For example, after the first flv~ years, recaptttre could be reduced by 10% per year for the next succeeding 10 years (see attached pro- posed bill). We believe such terms would be effective because Americans just do not think in terms of time periods as long as 15 years in the future, especially PAGENO="0743" 729 in connection with money and investiueiats~ Pifteen rears ~ longer ,th*il Ameri- cans are willing to hold a substantial, Illiquld, low~y*teld Investment, unless they are in fact dedicated to agriculture and open spaces. Such a lengthy recapture provision would, hoWever, be da~nagjng to legitimate farmthg and ranching heirs in that their ability to linancefarm operations would be impaired and may result In low crop yields. We bei1ei~e, therefore, that the provision requiring the decedent to have either held h1~ i~nt~rest in the qualliled real property for the five ye~trs immediately prior to his death or inherited it, plus the provision computing the value under the ejection as the higher of the qualified use value or the adjusted basis of the proJ~erty In the hands of the decedent Immediately prior to his death constitute adequate safe- guards to prevent abusive use of the special valuation election. coNcLrsxox This statement, together with other statements and data available to the Committee, conclusively demonstrates the urgent need for Immediate passage of the remedial legislation to prevent the federal estate tax from cowpell~ng the destruction of agricultural and open spiwe lands. Furthermore, this statement conclusively demonstrates that such legislation can be enacted without creating a loophole for abusive use of the law by briefly holding agrIcul~ura1 and open space lands in order to shelter from the full measure of the federal estate tax the passage of shbstantlal funds from generation to generation. Only Congress can prevent the federal estate tax from destroying these lands because Section 2031 of the Internal Revenue COde of 1954 requires that all prop- erty Included In the gross estate be valued according to its full value at the time of the decedent's deatb~ A spokesman for the Internal Revenue service admitted that the IRS had been aware of the problem for sears, but pointed out that the tax law required the Service to assess the tax on the basis Of the value for which the land could be sold rather than on the value according to Its use (see article by David A. Anclelman, New York Times, May 14, 1~72, éopy from Congressional Record, Vol. 121, No. 2, January 15, 1975 attached). The Treasury Itself has estimated that a change In the tax~ law to permit agri- cultural land and open spaces to be valued on the basis of current use rather than "fair market value" would result in a loss In tax revenues of only 20 million dollars per year (see 94th Congress, 2d session, Committee ou Ways and Means, IJ.S. House of flepresentatives, Background Materials on Estate and Gift Paxa- tion 62 (March 8, 1976). Surely 20 mIllion dollars pe~ year is ~. small price to pay to preserve our agricultural lands and agrici~Utnra~tprodu~tion c~paeity. In fact, when measured against the cost of other gove~men~ aid to agriculture, 20 million dollars Is a nominal sum indeed to protect this critical resources and Industry. The task remaining is for Congress inotir BIcentennial Year to enact this law to put an immediate halt to the presently continuing destruction of our agri- cultural and open space lands by means of 4eterniiziing the federal estate taxes on such lands according to the value of such lands for c~mmercial, industrial and residential uses. COMMENT UPON CERTAIN OTHER PRoPOSALS FOR CHA1~TGE$ I]~1 TIPt nsm~rn A~D GIFT TAX LAWS I. Income T~aation~ of TJnreaii~ed Gain on dppreciated PtiQp~r~~ qt J~eath I am opposed to the imposition of an income tax on `the unrealized gn~u on appreciated property at death as an additional, tax superimposed on the estate tax. I believe that most lawyers practicing in the estate pinnning and estate administration field are opposed to such a tax. The most serious problem in the administration of estates today Is Insuflicient liq~id1ty to pay the death caste, o~ which the federal estate tax Is usually the largest and `most troublesome. The federal estate tax Is a steeply pr~gressive tax, and inflation has pushed many estates into significant estate tax bracl~ets. Only a decade ago, estate taxes would not have been a great burden for many of these estates. InflatIon is, In effect, visiting upon our citizens an automatlO dnntial Increase itt Income and estate and gift taxes. Let's look at a fairly typical e~tample' of a~ `decedent whO starte& his own business thirty years prior to his death. Th~ fair ~árket ~a1tie of his meet- PAGENO="0744" 730 porated' business at the time of his death may be $400,000.00, but `hid adjusted basis, Immediately' prior to his death, for his stock in the bu~iness `may be only $30,000.00 if be built up the business over the yefirs from retained earn- ings. He will probably have `a' house worth about $65,000.00, but be may have paid only $30,000.00 for it. He may have other assets worth $50,000.00 for which he paid $25,000.00. For the sake of simplicity, if we assume he has no personal debt,. the gross estate, of this decedent is ~$515,000.00, and his adjusted basis for such property Immediately' prior to his death, is $85,000.00. If his, estate obtains the maximum marital deduction, it will pay estate taxes of about $68,000.00, a little' more than the value of his home and amounting to about' `13%'% of huis gross estate. `$68,000.00 is a great `burden on this estate, especially `if there is also a state estate tax in `e~cess of the federal estate tax credit, `but one which can probably be financed out of the busiiie~s over a period of years. But if we add a capital gains tax of 25% on the $430,000.00 in unrealized appreciation, then' we add another $107,500.00 in federal taxes due at death, to make a grand total of $158,500.00, or 30.8% of the gross estate (allowing for a deduction from the gross estate for the capital gains tax.) Few such families could finance his kind of debt from the business, and, hence, would be required to' sell t1~e business to pay the taxes. Needless to say, the Same scenario would hold true for farmers, ranchers and oper~ space landowners. The very concept of imposing an income tax on unrealized gain is foreign to our system' of income taxation. It Seems inequitable on its face. It imposes an income tax on an involuntary but inevitable event. Furthermore, determination of unrealized profit or loss will, generally not be an exact computation of the profit or loss that would actually be realized qn a sale. Finally, such a tax would reward the virtues of industry, thrift, wise risk taking, and `sacrifice to help the younger ge1ler~tion by forcing the sale of such investments and taxi~ig away a very large part of the proceeds. In essence, imposing an income tax at death on unrealized gain is nothing' more thap a cheap trick to increase federal death taxes which, because of in- flation, are presently too high. I am unimpressed with the two arguments ad- vanced in favor of imposing such a tax: (1) that `the present system locks people into their present investments until they die and (2) that the present system discriminates against those who sell during lifetime. In my experience the lock-up factor influences only the very elderly and the very infirm, and, in such cases, the lock-in period is relatively brief. Others will sell if they are of a mind so to do when the price is right. As for the supposed discrimination against those who sell, most lifetime sales are usually voluntary and ,made after weighing all the factQrs, Including the Income tax. Just about every aspect of tax law can be construed as discriminating against some person ,or class of persons who choose to do or not to do something or who cannot meet the requirementa of some provision bestowing favorable treatment. But this does not mean' that our, entire body of tax law is unfair or a poor system for allocating the burden of' supporting the government. If both the proposed legislation to prevent the federal estate tax from com- pelling the destruction of agricultural and open space lands and legislation to impose an income tax at death on unrealized gain were passed, the net effect would be that families would still be forced to sell agricultural and open space lands to pay death taxes. II. Elimination of the Step-up Basis at Death I am opposed to a carry-over basis for estate assets. It seems to me only plainly equitable to step-up to fair market value the basis of assets which have been subjected to taxation on fair market values at the steeply progressive estate tax rates. I see no merit to' a carry-over of `basis for assets qualifying for the marital deduction `because It seems to me that the marital deduction was a con- sideration in establishing the present estate tax rates and estimating the actual Impact thereof in most eases. III. Increasing the Estate Tax Exemption and Providing for a Minimum Maritat Deduction I am in favor of increasing the estate tax exemption from $60,000.00 because I think an upward revision of this specific dollar amount exemption to take into account the effects of infjation is long overdue. Such, a provision would largely eliminate the estate tax in a large number of cases in which no estate PAGENO="0745" tax should be applicable, such as the death of young meji with young tamilles and estates, includiiig life lnsurance,.of about $800,000,00 to $35O,OOOA~O. Inflation has pnt these estates Into a position of owing substantial estate taxes, and I believe it is time to rectify this situation. IV. Increasing the Gift Taco AnngaZ EcocZuslon and the Lifetime ~coeniption a~td Integration of the Gift and Estate Taxes The gift tax must be the most unintentionally vtólatêd of the fec~Era1 tax laws. Most people are unaware that taking title to shares of stOck in joint names with their spouse or children, or that giving their wife a new car or a diamond ring are taxable events. Moreover, such gifts by those who are ignorant of the law generally go untaxed because the 1~E~t does not discover that a gift tax return should have been filed, ~1~hus, lack of knowledge ~m the part of the public at large and lack of adequate methods of enforcement discriminates against those few conscientious taxpayers who are knowle~geabie and who file gift tax returns accordingly. I don't have any answers to the problem; but I think that raising the annual exclusion will help eliminate many of the innocent violations. Increasing the an- nual exclusion and the leftinie exemption is appropriate in view of the extra- ordinary inflation since the present arnotints were estab1ishe4~ Unless something can be dohe to adequately, enfotce the g~ft taxiaw, integration of the gift and estate taxes would only compound the inequity of present condi- tions. I would proceed cautiously with any changes here, and I would not disturb arrangements made under existing laws. In any event, if the gift and estate taxes are ultimately integrated, the estate tax rates, which are too high now, should be revised downward to equal the present gift tax rates. Respectfully submitted. E~ EDWARD MCGINTY. [From the New York Times, htay [4, 1972j ESTATE TAXES flnrVE J~ARMER5 Qrr LAND (By David A. Andelman) Thousands of American farmers are beitig driven off theli &nds-fo~ced to sell their farms tO real estate s~eciilators, some Of thein' say; because of the method used by the internal Revenue Service to assesS inheritance taxes. Such taxes are assessed on what the land could be sold fo~rather than what it is worth as farmland. Thus, many people who have inherited farms have had to sell them to developers simply to pay tbO taxes. As a result, the revenue service is be~~g termed p~trtly rqspQn$lble for destroy- ing a s~g~ent of American agriculture gnd, ~t the Samefji~9~, a~ceIerat1~ag the spread of. the.$uburbs to the rural areas of the Unite4AState~. Over the last ~ecade, the value of agricultural latus in ivid~ eti~oti~ of the nation' within easy access to metrOpolitan areas há4 skyrocketed as laM specula- tors have bought up every available piece of property, Tb~ ?aille, o~ t)j4s land for agriculture,, however, has largely remaip~d' consta4t~or b~1s `deciIne~ ;, The. Internal ~OvenuIe Service insists on assessing ~l~t hgrieuitural 1a:fl~ at the "pric~ at which property would, change `bands bet*~ti ~ willing buyer and a willing seller." The result j~as been that farmers .hol~ing ~o~t~' ~lp~e,'va,Iue fQr develop- ment is fWe ,to ~O'times its agricultura1~Ortb h~l~O n ~d~céd to sell fiielr..pro- peI~ty to the waiting speculators simply' tO paytbeir InheritanCe' ta'es, whh~h run: as high `as 25 per cent. Children who would have reitiained dii th~ land'are `being~ forced off. . ,.,., ., , ` Most of this .press~1re has been focuse&ôui the spreading areas: p~i the fringes of the suburbs where metropolitan America i~ pu~hhng out to meet' tural America-~areas such as the farther reaches of Suffolk Cotiuit~, `L.I. ; suhilin Phoenix, Ariz.; the extreme,'northwester: part of Cook C~uunty In Illinois, and the Sierra Foothills' regiOn of California. , ` "Once farmland is given to speculators that's the final step `a~ far as agri- culture Is' concerned," said James E. Cross, a ,farrne~ In senilri~ral ~utCbógue, LI. "!ou're taking land that took 25,000 yeaFs to ~~velo~, ~ amazing land that is rich and, fertile, and overnight you bring in bul~dozers and sopk houses en it. We `all pay fOr it in the lông run." ` ` ` ` . ` PAGENO="0746" 782 Another Cutchogae farmer, John Wickham, cited the situation of a neighbor with a 60~acre farm in one of the best potato-producing areas in the tlnited States. The neighbor, who bad asked not to be identified by name, inherited the farm from his mother two years ago upon her death. The farm was worth about $800 an acre if used for agriculture. But the revenue service valued it at $3,500 an acre, which Mr. Wickbam noted "Is the fair development value," and the tax alone came to about $1,200 an acre. CALLS SALE "FORCED" "This means that this chap is a very good farmer," he added, "bat he had to take out a tremeildous mortgage to pay the inheritance taxes, a mortgage with 9 or 10 percent Interest, and he sImply can't pay it off-not with today's price of potatoes. So he has to ~el1 it. In actuality, they [the Federal Governmentj forced its sale, very simply." In Barrington, Inti., Xaver Schmid, a 72-year-old farmer who Is worried about the problem that will arise when he dies, cited the case Of a 90-year-old neighbor who died and left a 500-acre farm to his wife. "They haven't sold the farm yet," Mr. Schmkl said, "as the estate is still in probate. But hiS wife is nearly 90, and when she dies taxes will be levied all over again and the soils will have to sell the farm for sure to pay taxes." That the situation became most acute very recently Is largely attributable to the neWly developing pattern of change in suburban America. GROWTH ON FAR FRINGE The 1970. censits revealed that the fastest growing segment of the United States was the suburbs and the fastest shrinking was the rural areas. But of even greater significance w~t~ the evidence that the fastest growing segment of the suburban population was in the so-called "exurban areas"-those counties in the far fringe of the suburbs, between suburbs and countryside. It is here that the real estate speculators are most busily at work and where the pressures on the remaining farmers are the strongest. There are no statistics to show bow many farms are going to speculators. Many are quietly sold but continue to be farmed for several years, even decades, under "leaseback" arrangements, until the land becomes so valuable that the speculator finally moves in and put a halt to the farming. NEED FOR LEGISLATION SEEN A spokesman for the Internal Revenue Service, Edward Work, said, "We've been aware of the problem really for several years and, of course, what it boils down to is that under the law we have no alternative but to set the tax on the value the land sells for rather than on the value the property would be used for. "It would take legislation to chance the practice." The legislation on whleh the current revenue service practices are based dates to the Revenue Code of 191~, Section 2O~.1, of which says that property must be valued at its fair market value. A service spokesman said, "It has been applied consistently since that date." There have been numerous attempts at reform. Representative Graham Purcell of TexaS, sixth-ranking I~emocrat on the Rouse Agriculture Committee, has introduced each year for the last four years a bill providing for a change of the valuation criteria. At last count, there were six bills before the House Ways and Means Committee and one in the Senate~ all waiting for action that their sponsors generally believe will probably never come. "~ac~ year they get buried in the hearings on general tax reform," Mr. Purcell said in a recent interview. "Wars and Means just happens to like the extra revepue thelaw pulls in the way it stands." The extent. o~ the problem aild the concetn it has aroused In agricultural America is ii~dI~ated by~ the search for the methods to circumvent the revenue regulations. In the IDade County area surroiftidhig Miami, almost all farms have by now been incorporated. The corporate farmer is able each year to transfer a small PAGENO="0747" 733 ampunt of ~toek-up to ~3,0~O apiece is tax-exempt under gift tax statut~s-~-to his children as gifts, easthg the final impact of inheritance taxes when he dies. A few states, Including New Jersey, California and Maryland, have either set up or given serious consideration to establishing agricultural land use districts. They require farmland under regulation to remain in farming for a certain perlo4 of years, ~isuaily at least 10, or indefinitely. But In many areas, the revenue service has not chosen to recognize these districts for estate tax purposes, ACCEPTED EY GOVERNMENT In California, the Land Conservation Act of 1965 enables a farmer to contract with the county government not to put farmland up for sale for at least 10 years, enabjing the state to assess the land at agricultural rates. And, state officials said, the Federal Government has accepted the state assessments for Federal purposes. But a new and more recent law may change this. It provides that if not enough of this restricted land Is sold in an area, the county assessor may use the Income of the land as a means of determining Its value for assessment purposes. Joseph A. Janelli, governmental affairs specialist of the California Farm Bureau Federa~1on, is concerned that "the I.R.S. just might say this new law is a temporary expedient and we do not have the right to do it this way." ARRANGEMENTS ARE URGED Mr. York, the revenue service spokesman, said "there Is a possibility" that an agricultural land use district "could affect the Valuation-in effect discounting the val'ttation In some situations." But he said, even so, the value would neirer reach the agricultural value. So, the Oalifornla federation has begun to advls~ members to make their proper arrangements well In advance of death-giving land or corporate shares In land to their children over the years to take advantage of the gift tax exemption. "All this is fine," said Mr. Wickham, the Long Island farmer. "But I can't do this. I need cash loans on my property each year In order to operate. If I go to a. bank and say I've given shares to my children, that I don't have clear title, they'll throw me rig~ht out." Dean F. Tuthill, a professor of agricultural economies at the tYnlversity of Maryland, said that there were only a handful of states that bad been able to figure out any method of easing the burden of estate taxes for their farmers. COAST LAW CITED Most special agricultural taxing districts set up to help farmers are applied only to local property taxes and not to federally administered estate taxes. Professor Tuthill cited, as one attempt to ease Federal taxes, California's statute, which he said was a prototype for other methods of "preventIng Inten- sive development of farmland," including a bill In Maryland last year that would have allowed farmers to sell their development rights to the local county, farm- ing It themseves but paying considerably lower taxes. Systems such as this or one newly instituted in Sixf~oik County, L,I.-wbere the county plans to purchase, at the start, some 8,000 acres of prime farmland at speOulative prices from the farmers, then lease It back to the owners-are other solt~tIons proposed by agricultural economists in place of changes In the revenue law. "Th~re are so few ways open to preserve this valuable resource," Mr. Wickham concluded. "If the I.R.S. continues to follow this policy, it will put all agriculture out of business on Long Island within a generation. And who knows what will happen everywhere elSe In this country ?" tProm the Wall Street Journal, May 15, 19141 ThR251.~YEAn-OLD MANsION PIuYVIDES FEELING G1~ "Ro~~rs" l~tr~r DOMINATES ThEIR LIVES (By bail Bronson) ShIRLEY PLANTATION, VA.-Po Walk Inside the venerable brick mansion here with its paneled rooms and Its oil portraits of long~dead ancestors, is to enter into the measured pace of the 18th Century. PAGENO="0748" 734 It Is easy, ~in the shadowy half-light of a fading afternoon, to envision a style of life two* centuries removed from the busy world outside-to imagine squires with powdered wigs gathered around the Chippendale dining table, drink- ing sherry from graceful crystal glasses. Thomas Jefferson dined at Shirley. Robert B. Lee's mother was born here. But C. Hill Carter, the 20th Century owner of Shirley, is not a squire, and he doesn't have a `powdered wig. He has a crew out, and should you visit his 251- year-old mansion 25 miles east of Richmond in the Virginia tidewater country, you may find him in paint-spattered shoes and baggy overalls, touching up an out- building. He often does such work himself-to save money. Nor do Mr. Carter, his wife, Helle (rhymes with Nellie), and their three children dine very often at that splendid table of polished mahogany on the main floor. They usually eat at a picnic-type table in the basement, seated on folding chairs beneath the bare pipes that service their 1910 sink. They eat in the base- ment because they want to maintain the main floor in all its 18th Century ele- gance, full Of valuable antique furniture and American art. `RUINOUS TAXES That is the commitment that has shaped the lives of Hill and Hello Carter- a commitment to maintain and preserve an 18th Century mansion on a 20th Century income. 1\~[ore than that, they are committed, despite rising expenses and the threat of ruinous taxes to pass Shirley on to their children and their children's children. They intend to keep Shirley in the Carter family, where it has remained for nine generations. "In our society nobody has any roots," Mr. Carter drawls. "Everybody's mobile. When people come here and tell me how lucky I am to own Shirley, I'm right proud. We're determined to stay and keep these things." Plenty' of folks come to see Shirley. To help offset expenses, Mr. Carter opened Shirley to tourists some years back, posting a billboard near Williamsburg and distributing brochures locally. Last year, more than 10,000 people visited the plantation, often getting a guided tour by Mr. Carter himself, who clearly relishes the opportunity to take time off from endless odd jobs around the plantation to recall his family history and the glories of the past. The white pOrticoed mansion dates back to 1723, but Shirley Plantation itself is even older. It was founded in 1613, only six years after the colonists arrived at Jamestown. While the land belonged to tobacco farmer Edward Hill, the Shirley man~iop wasn't bulit until his daugheter Elizabeth married John Carter, the son of a giant in colonial Virginia, William Robert (King) Carter. RANDOLPHS, LEES, AND BYRDS Contemporaries: called him .~ing because he owned a huge chunk of what Is now the state of Virginia. King Carter amassed his wealth by deeding defaulted land to himself ~s land agent for Lord Fairfax and England. He lived quite comfortably. on another plantation, cultivating tobacco with the help of 1,000 slaves. Over the years, hi~ descendants intermarried with such leading Virginia families as the flandolphs, Lees and Byrds. By comparison, King Carter's ninth-generation descendant has come. down in the world-although, on paper at least, Hill Carter is a wealthy man. "I reckon I'm worth $1.5 million," be mutters bashfully. "But I still feel like I'm scra~nbling fo~ pay the grocery' blll~." Despite his assets, Hill Carter barely nets $15,000 a year, mainly from his tourist trade and some, land he rents t~ a gravel conipany.. To convert hisS assets to spendable cash he'd have to.. do the one thing he is committed not to do: sell Shirley Plantation. The problem, of maintaining a large estate isn't unique to the Carters. Many families find the financial burden too much or the way of life un~ippealing; usu- ally, they sell their property for development or for some sort of institutional or foundation use. In Britain, the National Trust accepts country estates from owners who provide endowments to maintain the property in perpetuity for pub- lie access: In return the family may live there rent-free. The National Trust for Historical Preservation in the United States accepts property gifts with endow- ments, and Colonial Williamsburg buys land for the tourist trade. But Hill Carter wouldn't consider passing Shirley out of strict family control. As a result, Hill and Helle struggle hard to keep Shirley both livable for the family and attrhctive to tourists For Hill life is a wall that need spacking and PAGENO="0749" 735 plumbing that needs fixing; currently, he's trying to complete some formal gardens around the house and build a driveway to the main higbway~ Helle opened a gift shop last year in one of the outbuildings and also hopes to start a small restaurant operation in another building. Shirley Plantation mirrors much of Southern history in its evolution from tobacco plantation to wheat farms to the homestead that Hill Carter inherited. "My grandfather was wounded at Chancelorsville and was forced to quit work- ing around 1884," says Hill, "so my dad started farming when he was 16. He never got an education, and financial things weren't easy for him.. He spent all his time farming just to feed his family through the Depression." Hill inherited the estate in 1952 through an elaborate plan to keep Shirley in the family; soon, the farmland was leased to others, a gravel mining company had leased several hundred other acres, and the Carters were, seeking to build up tourist traffic to the house Itself. "When other people are out on Sunday drives. I'm showing people around the house," says Hill. Still, life at Shirley has its compensations. Hill and Helle enjoy sitting out back watching the historic James River roll by; many evenings are. spent enter- taining friends in Shirley's stately and ornate dining and drawing rooms. Though the family usually east in the basement, the children, Charles, 11, Randy, 10, and Harriet, 9, are allowed the run of the house and property.. "I don't want to turn this place into just a museum," says Helle. Whether Hill Carter will succeed in his ambition to keep Shirley Intact for his children-and whether they will want to stay at Shirley-is open to question. Hill figures the inheritance tax alone n Shirley would be about $650,000. at present rates. . , But Hill and Helle figure it's worth the effort. "If money was the only thing in the world, I'd `leave," says Hill "But it's not. Most of the important things in the world can't be bought and sold," Helle adds. "It's gratifying when people come and appreciate this as part of their heritage~" [From the Baltimore Sun, May 19, 1974] DI5APPRAmNG FARMS (By Michael K. Burns) In the years of agriculture abundance, not so long ago, United State's farm policy was aimed at moving land out of production. That policy did not seem to work so well then but its effects are being felt today when the natibn is realiz- ing it might be better of'with niore farms and farmers. Rising prices at the supermarket reflect the world's demand' `foi~' more fOod. And the environmental movement has inculcated a reverence for opeli space and a revulsion against the devastation of suburban sprawl. Expansion of th~ domestic farm system seems to answer these non-farmer needs of society. Forces are at work to create a coalition between the farmer and `the environ- mentalist to preserve farmland as a privately held public heritage. But the alli- an~e is sti1~ in the formative stage. Farmers distrust the conservationist who would freeze the value of his land under land-use laws, and chafe at his efforts to restrict uses of chemical and pesticides. Conservationists and consumers are wary of the producers of ever-more-expensive food and the owners of large 8preads of high-priced rural real estate. Land speculators have perhaps been the key element In the forging of the ~ommon interest. Population pressures and the evergrowlng highway system created new fortunes for property holders who stood In the path of progress. Farmers did not create the boom, but they were quick to appreciate Its possibili- ties for a windfall. A glut of reckless, shotgun speculation In farms' throughout the state followed. And those farmer's who sold' out made It even harder for the1~ neighbors to resist. Some 2.7 million acres in the state, or 40 percent of the land, are in farm production. By one estimate, that amount' will dwindle to 1 `million acres `by the year 2000. Recognizing this. undesirable trend, the Maryland Senate last year ordered th.e Secretary of Agriculture, Y, D. Hance, to make a study of means to preserve farmland. Mr. Hance appointed an 18-member Commission with Frank L. Bentz, Jr., University of Maryland vice president for agricultural affairs, as chairman. The commission has set as a goal the preservation of 2.5 million acres of agricultural land. Members are uncertain how fast farmland will be eaten up PAGENO="0750" 73~ in the future: one subcommittee suggests 35,000 acres a year, another 62,000 acres. But they seem to agree that speculation, or investment, is a greater factor than the immediate demand for housing or commercial development. "Agricultural and commercial forest land acreage will decrease more than three times as much as urban-related land commitments will increase" by 2000, the group said in an interim report. Some of that land will be granted a temporary reprieve, as speculators rent it to farmers, but Its fate is sealed. This despite the fact that there will be 50 percent more people living on an acre of Maryland In 26 years than there are today~ As a commission subcommittee noted, preserving agricultural land can only be based in part on the actual demands of future population growth. linrelated economic factors influence a number of Individual decisions to give up* farming and to take advantage of the speculator's offer. Farm prices are expected th increase and provide a return of about 15 percent on capital (exclusive of land), the commission reported. But a shortage of labor, heavy Indebtedness and taxes may encourage all but the dedicated to give up. Farm prices have shot up all over the state with little relationship to produc- tivity and food prices. Farms that sold for $200 an acre In Frederick county 15 years ago are now worth $30,000 an acre by the new shopping mall. Even resi- dential lots, minus sewer and water, are selling at $4,500 an acre. In Anne Arundel county, developers are paying $3,000 an acre for average farmland as they leapfrog over sewer-connection bans in Montgomery and Prince Georges counties. Partially influenced by the expanding Black & Decker power-tool plant, land in the Hempstead area of Corroll county is selling for an unheard of $7,000 an acre. "A couple of years ago, $1,000 was high for land in this area," recalled Paul R. Albaugh, a dairy farmer. "Now, I don't know of any land sold that's going to other farmers.. . they can't afford it." "I don't think you can talk to a farmer who hasn't lost ground over the last five years," said Carroll Leister, whose grandfather bought the land he farms today. The small parcels of land a farmer rents for $15 to $20 an acre are sold off each year as land values rise, he explains. "The by-pass Is going through 25 acres of our land and that will bring more houses," Mr. Leister said. "I guess in five years after the road is built we'll be out of here." Developers and farmers covet the same type of land, Mr. Lelster added. "That's the thing that hurts: they're buying good flat, cleared land, not the woods or the hilly areas," he said. According to the state, more than 20 percent of Maryland's "prime" farmland has been lost to urban use. The commission headed by Dr. Bentz is to make final recommendations on legislation to Mr. Hance next month. So far, the group has explored several possibilities which have been discussed at a series of hearings in the state. The revision of federal estate taxes and state inheritance tax is one promising idea. Senator Charles MeC. Mathias Jr., (R., Md.) and Representative Goodloe B. Byron (B., 6th) have introduced bills to change the estate tax, so that heirs are taxed on the agricultural value of farmland instead of on "fair market value." `The lower valuation could make it easier for heirs to pay the taxes without selling the farm; if they did or if they developed the land, they would be subject to a retroactive higher levy. The chairman of the Maryland Env1ronment~l Trust and the Maryland Historical Trust support the measure as a valuable open-space tool. The loss of farmland due to the estate tax valuation has not been extensive. Many heirs are all too willing to sell and farmers do the same thing to create their retirement annuity. But it does help to keep farms in the hands of those families who want to continue at It, and they are becoming more rare. Herbert and John Wisner of Mt. Zion worked their father's farm since they were children, but had to form a corporation to save the land with a mortgage when It was inherited as an estate. "They should have done something to help the farmer in a situation like this," Herbert Wisner said. Other plans considered by the agricultural land preservation commission in- elude variations on programs in New York and New Jersey. New York permits farmers to create agricultural districts with powers to prohibit certain local ordinances that interfere with farming, to bar the use of public funds for utilities installation and to receive favorable tax assessment treatment. The New Jersey plan, which is only a proposal made to the governor, calls for each municipality to set aside a certain percentage of prime farmland for ~preservation. A state tax on real-estate transfers would pay farmers for the PAGENO="0751" 737 loss of their development rights by l-mvlng the land usefrozeu1n~preser~es. Under the New Jersey plan, farmland owners could claim their 4e~veleprnent~rigbt pay~ ment today, or wait on the cbarU~e that tbei]~ rights will appreciate In the future. Speculation could continue in these rights or easementS aud investors could be- come richer. But the public would not be thepoorer. Maryland was the first state to pass a preferential farm property tax assess~ ment law, taxing farmland at a lower rate* than ~esldentlal or tomnierelal prop- erty. Economists claim the la~W has helped to kuep land In production, though the evidence is tenuous. There is a tax recapture provision penalty if the use is changed, but that Is a weak restraint against development. This year the legislature enacted a law permitting farmers to give up the development rights to the state. En exchange for freezing hte use of his land In farming, the owner woul4 reduce his local property taxes and reduce the value of his estate for federal ta±es upon his death. Without any purchase agreement, however, its chances of success are slim. From this mix of interests, and of economic Incentives, the attrition of farms and farmers may be stemmed. The benefits of open spa~ Will be shared by all. Phillip Alampi, New Jersey's agriculture secretary, recently explained how self-interest can work constructively in this field. "Farmers have a selfish interest in preserving open space," he said. "Without It, they will, go out of business. Urban and suburban people have a selfish Interest in preserving open space. Without it, they may exist, but they will n~t live." [From the Baltimore Sun Feb. li~, 1974] ENDANGERED LABEL ON EA$r Co~sr FAultS (By I~aac Rellert) The East Coast farmer has been changing to a rare and endangered species just when a crowded congested society has come to need him most. For decades, while built-up concrete areas have been growing around big cities like warts, farmers caught in the crunch o1~ fast-rising costs and shrinking profits, have been abandoning agriculture, The old-timers are carrying on, expanding and consolidating their holding, but with the increased capitalization, it becomes almost impossible for a youngster to break in unless he inherits. And increased valuation of land for development puropses is a continuing temptation to the farmer simply to sell his holdings for the building of supermarkets and retire from the field. As if crowding by urban areas, skyrocketing capitalization and the cost-price squeeze were not enough, certain government tax policies have also tended to pressure farmers into getting out; and now land-use legislation, one version of which has already been introduced into the Marylabd General Assembly, has farmers worried. They fear that b~ legislative fiat, their equity, their security, their retirement bank account that they keep ~Lepo~lted In land, may be wiped out. The extinction of the East Coast farmer, like tile exterminatiOn of other rare and endangered breeds, is more a problem for the public than It is for the breed. Quite aside from the production of food (whb~h for the first tlme In memory is becoming increasingly critical), quite apart from nostalgia for "old time rural values" and a way of life that keeps looking better the further we pass from it, farms-at least green open spgce~-are essential to ecOlogy, to keeping a balanced environment, to malnta1nin~ an esthetic harmony. Whereas in other areas real estate taye~ are based on the highest market value of land-~whjch usually would be its speculative, value for development-in Mary- land, farm land Is taxed as farm land-which means lower, rates, commensurate with its lower earning ability when used for grqwliig crops. But the federal government has not seen fit to follow a similar practice. There are no federal real estate taxes, but there Is a federal estate inheritance tax, and the Internal Revenue Service insists on assessing all agriculture land at the "price at which property would change band~ between ~ willing buyer and a willing seller." Any land within easy access to metropolitan areas can attract numerous will- ing buyers eager to acquire all they can for speculative purposes. The result has PAGENO="0752" 738 been that In some areas, land values have skyrocketed to five to ten times what they would be for agricultural land. And so, when parents die and their children inherit the land, they find them- selves billed for a federal inheritance tax-which may run as higs as 25 percent- that is so high they are forced to sell the land to speculators in order tie pay it. In one instance, land that `was worth $800' an acre for agricultural purposes was valued `by the IRS ait $3,500 `an acre, which was its "fair' development value." The tax alone came to about' $1,200 an acre, and the farmer had no choice but `to sell it for development in order to pay. In fact, the federal tax laws had simply forced the farmer off the farm and the land out of farm production. It is not merely IRS administrative policy `but `explicit legislation that says that property must be valued at its fair market value, and so. it will `take new legislation to make a change. This year, Senator Charles McC. Mathias, Jr., (R., Md.) introduced a bill that would change the practice bringing it into line with that used in Maryland and other states, so that the IRS, in considering the value of land for tax purposes, would use its value as an `actual earning resource rather `than i'ts market value. In a Senate statement, Mr. Mathia's pointed out `that without such legislation, every time a farm passed to an heir, the heir would `be paying most or all of the income `be could earn from his farm land just `to pay the taxes. The situation is impossible, and "the effect o'f this (IRS) policy is `to force many farm families `t'o sell `their farms in order to pay the esta'te tax-regardless of their attachment `to the land or to the occupation of farming. And `the result of suc'h forced sales is, in the end, a grave and immesaurable cost to the community." His bill includes safeguards that prevent land held by speculators from qual- ifying `at the lower rate of tax, namely that the property must have been used as farm, w'ood or opeti scenic land for at least five years prior to and must con- tinue to be used that way for five years after the estate tax return is filed. One of the interesting developments `in the farm land picture is that because of the world-wide food shortage and the energy and fertilizer shortages, farm commodities have been increasing in value so rapidly with next year's har- vest `the value of farm land may nearly equal its value for development. From the public's point of view, at least one `aspect of the situation has become perfectly clear. Despite the name "agribusiness," farms are not merely business; they are a natural an'd esthetic resource of `the entire community, and `the East coast farmer, who is their steward, as a rare and endangered species, needs some help to be saved. [From the Ba1timo~~e News American] FEDERAL TAX GRAB COUNTERED: STATE AcTs To SAvE FARMS (By Steven Norwitz) In upper Harford County, John Brown (not his real name) tills a 650-acre farm he'd like to turn over to `his c~itildren when he dies. `But farmer Brown estimates that when he passes on, his family will face a federal estate (inheritance) tax of $400,000. As a result, the Brown family will `be forced to do what the Johnson family did with their 100-acre farm in H'avre de Grace a few years back-sell it to developers. The federal estate inheritance tax, which often amounts to a third of the development value of a farmer's land, is one reason why Maryland loses an esti- mated 35,000 acreS of farmland a year to development, according to the state Department of Agriculture. In 1969, the latest year for which figures are available, 44 percent of Mary- land's land areas, or abou't three million acres, was devoted to agricultural use. lit is projected that `the amount of farmland in `the state will drop to 2.4 million acres, or 38 percent of the state's land area, by 1986. To help slow the trend, the Maryland legislature `this year passed a bill designed to aid the farming family that `wants `to pass its farm down from one generation to `the next. For farmers `who agree to permanently turn over `the development rights of their land to the state, the bill provides that the farmer would `be assessed at their agricultural value, about $600 an acre, instead of potential development value, noW ranging fro'm $2,000 to $3,000 an acre. PAGENO="0753" 739 The aim Is to significantly ctit the federal estate tax on the property, enabllng~ the family to keep the land for its agricultural use. "This would help people Who have bad farms that have been in the family for generations and want them to be kept in the family," says T. Allan Stradley,. president of the Maryland Farm Bureau. The state, meanwhile, would preserve some of its open spaces and maintain' a $425 million a year Industry. While the bill is considered a good concept, its effective implementation hinges on two unknowns. "First," says state Sen. James Clark, Jr., D-lloward, a co-sponsor of the bill,. "we're not absolutely certain the IRS (Internal Revenue Service) will recognize this." The federal government does Its own assessing of property when calculating, the estate inheritance tax. "Second," Clark adds, "if you give up the development rights to your property and the property all around you is turned into subdivisiofls, the plan Won't work. If these roadblocks are Worked out, however, Clark feels "there are a good many people who will go for it." Clark himself would be one of them. The senator runs a 500L.a~ire farm on Rt. 108 across the road from Columbia. "The estate tax on this would definitely cause us to lose the land," he says. "But I won't hesitate a mith~te (to give up the development rights to the prop- erty) if I was assured I wouldn't have development all around me. Agriculture is all we've ever done: that's all we want to do." While many farmers will be leery of giving away the huge profit potential of their property, Sen. William S. James, 0-Rarford, co-sponsor of the bill and. president of the Maryland Senate, says the bill is ",just a start" in the state's effort to preserve its agricultul-al land. Tilventually, James notes, Maryland may `adopt a plan similar to one in New Jersey which authorizes the state to purchase outright the development rights to a farmer's land. "The New Jersey green acres program," James says, "has permanently preserved one million acres (of its 1.4 milllon acres of farmland) by this approach." This summer a state Commission on the Preservation of Agricultural Land is to offer sweeping recommendations on steps the state should take to accomplish this purpose. _______ A BILL To amend the Internal Revenue Code of 1954 to provide for the deferral and transfer of liability for the payment of a part of the Federal estate tax on certain real property the fair market value of which exceeds the value of such property for continued use as agricultural land, unleveloped land, or historical sites Be it enacted by the ~S'enate and House of Representatives of the UnAted S~tates of America in Congress assembled, That (a) part II of subchapter A of chapter 11 of the Internal Revenue Code of 1954 (relating to credits against estate tax) is amended by adding at the end thereof the following new section: "(a) IN GENEaAL.-If the executor of an estate so elects, the tax imposed by section 2001 shall `be credited with the amount of the excess, if any, of the tax imposed by section 2001 over the amount of the tax Which would be imposed by section 2001 if the value of any interest in qualified real property included in the' grom estate is determined by the higher of either its value for the use under which it qualified in accordance with the provisions of subsection (b) of this section or its basis in the hands of the decedent (Immediately prior to the death of the decedent). "(b) Qt~ALIIPIED RIIAL Pnorznr~.-For the purposes of this section, the term `qualified real property' means real property substantially all of which is and, for the 60 months preceding the date of death of the decedent, has been devoted to- "(1) farming (the production of agricultural commodities), "(2) ranching (the raising of livestock), "(3) woodland (including land used for the commercial production of trees and land publicly used for undeveloped scenic or outdoor recreational purposes), "(4) beIng maintained substantially in its natural state (being undevelopel for a~ricu1tural or other purposes), "(5) maintenance of historical values and is listed in the National Register of historic Places, either separately or as part of a district so listed. Such real property shall include residential buildings and related improvements occupied on a regular basis by the owner or lessee of such property or by persons 68-872-76-48 PAGENO="0754" 740 employed by such owner or lessee for the purposes of operating or maintaining the real property and improvements described in this subsection (hi), and roads, buildings, and other structures and improvements functionally related to the uses listed in this subsection (b). "(c) INmxlLsT IN QUALIFIED REAL PROPERTY.-FOr purposes of this section, the term `interest in qualified real property' means- "(1) beneficial interest in the fee ownership of such property as sole owner thereof or as a joint tenant with the right of survivorshjp, a tenant in com- mon, or otherwise. "(2) any interest in such property or iii voting stock of a corporation described in paragraph (5) of this subsection, the value of which is includibie in the gross estate of the decendent by reason of any one or more of sections 2033,2035,20343,2037,2038 or 2041 of this chapter. "(3) beneficial interest in a land trust which holds the fee ownership of such property, if- "(A) such trust had 10 or less beneficiaries and "(B) such property comprised at least 80% of the value of all property owned by such land trust "(4) an interest as a partner in a partnership which hoid~ the fee owner- ship of such property, if- "(A) such partnership bad 10 or less partners and, "(B) such property con~prised at least 80% of the value of all prop- erty owned by such partnership. "(5) voting stock in a corporation which beneficially ow~ the tee owner- ship of such property, if- "(A) such corporation had 10 or less shareholders and "(B) such property comprises at least 80% of the value of all prop- erty owned by such corporation. For purposes of this paragraph, determinations shall be made as of the date of the death of the decedent. "(d) BENKFIOIARY.-For purposes of this section, the term `beneficiary' means that person or those persons to whom any interest in qualified real property in- ~luded in the gross estate of the decendent passes' or has passed from the decedent. "(e) Txi~is AND MANNER OF ELECTI0N.-Phe election provided for in this sec- tion shall be exercised `by the executor on the return required by this chapter if filed within the time prescribed by law or before the expiration of any extension of time granted pursuant to law for the filing of the return, and shall contajn the name, address and taxpayer identification number of the beneficiary or bene- ficiaries. "(f) REvoCATIoN OF ELECTION.-Tbè election made under this section shall be revoked with respect to the whole or any part of such qualified real property which is- "(1) converted to a use other than one or more of the qualified uses de- scribed in subsection (b) of this section; or "(2) removed from the National Register of Ristoric Places or mainte- nance of the historic values is discontinued if such property qualified for the election only pursuant to subsection (b)'(S) of this section; or "(3) sold or otherwise transferred. "(g) RECAPTURE OF Oaxni~.-Upon revocation of an election made under this section with respect to any interest in qualified real property or upon the dis- position of any interest in qualified real property with respect to which an elec~ tion under this section has been made, the credit allowed by this section shall be decreased by 100%, minus 10% for each twelve month period that such interest in qualified real property was held after the date that such interest in qualified real property was held for 60 months from the date of the death of the decedent, of the amount of the credit attributable to the interest in qualified real property with respect to which the election has been revoked or with respect to which a disposition has occurred. "(h) LIABILITY FOR PAYMENT.-If the amount of any credit claimed under this section is recaptured pursuant to the provisions of subsection (g) of this section, the executor, if such recapture occurs during the administration of the estate and prior to distribution of the interest to which such recapture is attributable, or the beneficiary or beneficiaries of the interest to which such recapture is attributable, if such recapture occurs subsequent to the distribution of such in- terest, shall give notice to the Secretary or hi's delegate of the event causing PAGENO="0755" 741 recapture Of any part or all of such credit pursuant to tbep1~Qvisions of sub- section (g) of this section, such notice to be g~veu at such tftae and in such manner as may be required by regulations prescribed by the Secretary, and the Secretary or his delegate shall (the provisions of section 6~O1 itotwithstaitding) redetermine the amount of the tax under this chapter and the amount4 if any, of the tax due on such redetermination, plus any interest due thereon, shall be paid by the executor or the beneficiary or beneficiaries, as the case may be, upon notice and demand or upon the expiration of any extension of time granted pur~ suant to law for the payment thereof. "(i) Cuoss RarunuNous.- "For lien against property where credit is claimed under this section, se'l section 6324(a) (4). "For interest payable on amount of any credit allOwed under this section which is recaptured under subsection (g) of this section, see section 6601(j).". (b) Section 6324(a) of such Code (relating to liens for estate tax) is amended by adding at the end thereof the following paragraph: "(4) Tjrow SEcTIoN 2017 Puorrnrv. "(A) Ln~x IMPosnD.-If the executor of an estate elects to claim the credit against the estate tax allowed by section 2017, the amount of such credit shall be a lien for a period of 15 years (unless sOoner released as provided in subparagraph (B)) from the date of death of the decedent upon the property (as defined in section 2017(b)) with respect to which the credit was claimed. If the credit relates to more than one parcel of section 2017 property, a lien is imposed under this paragraph on each parcel of such property in an amount which bears the same ratio to the total amount of the credit allowed under section 2017 as the value of that parcel of such property (for pur- poses of chapter 11) bears to the value of all the property to which the credit relates. "(B) RELEASIIS or LIEN,-The lien imposed by subparagraph (A) on any parcel of section 2017 property shall be released by the payment to the Sec- retary or his delegate of the amount of the credit subject to recapture from time to time under the provisions of subsection (g) of section 2017 plus any interest due thereon. "(C) Cuoss RErEnENcEs.-For interest payable on amount of any credit allowed under section 2017 which is recaptured under subsection (g) of Sec- tiOn 2017, see section 6601(j)." (c) Section 6601 of such Code (relating to interest on underp~tyment, non- payment, or extensions of time for payment, of tax) is amended by redesignatin~ subsection (j) as (k), and by inserting after subsection (i) the following new subsection: "(j) INTEREST ON RECAPTURE OF Cintmr ON SECTION 2017 PRorEwrv.-If the executor of an estate elects to claim the credit against the estate tax allowed by section 2017, Interest shall be paid at the rate of 4 percent per annum on the amount of any credit recaptured under si~bsection (g) of section 2017, computed from the date of the death of the decedent to (the date of the event causing the recapture. The interest shall run from the date prescribed by section 6151(a) for the paymettt of the tax imposed by chapter 11 on the transfer of the estate, without regard to any extension of time for such payment under section 61W. (a) (2), 6166, or 6166. The Interest shall be paid by the person or persons paying the amount of the credit rec~tpttired under subsection (g) of section 2017 at the time such amount Is paid." (d) The table of sections for part II of subchapter A of chapter 11 of sUch Code is amended by adding at the end thereof the following new item: "Sec. 2017 Credit for part of value of certain real property." Sue. 2. The amendments made by this Act apply to the estates of decedents dying after the date of enactment of this Act. Mr. BURLIiSON. We will next hear from Professor Moran. STATP4V~ERT OP GE~tALD P. MORAN Mr. MORAN. Thank you, Mr. Chairman. I am' pleased to appear before the committee to express~ my views about the operation `of the estate and gift taxes as we pres~ntiy have them. PAGENO="0756" 742 As a third generation American Irishman I would be making a mis-~ take if I did not note that today is St. Patrick's Day and that the~ acting chairman is appropriately wearing the correct colored shirt~ I would like to briefly give you an idea of my background. For 7 years I worked for the Internal Revenue Service. One of those? years I was an estate tax examiner. For 21/2 years I was with the exempt organization branch before this committee created the private~ foundation program in 1969, and subsequently I was in the regional counsel's office in Milwaukee, Wis. representing the commissioner in litigation before the Tax Court. I was also in private practice for a period of 41/2 years before I became an academician, if I can ever indeed understand what that term is. I do not have an ax to grind before the committee but I do have a set of values, as does every person who speaks before this committee. I would like to express my values and observations as to the structure from my experience. I have a prepared written statement which I would like to submit into the record and I would briefly like to sum- marize the important features of my statement. Mr. BuiuissoN. Your full statement will be include4 in the record. Mr. Moi~N. Gentlemen, it amazes me how lawyers are set to tinker with the tax statutes without first deciding what in fact is the pur- pose of the estate and gift tax structure. The present situation is that we are producing only $5 billion in revenue from the estate and gift tax structure. If the reform proposals that we are talking about this morning are adopted as this committee indicates in its background material,' we will cut the revenues of estate and gift taxes by 50 percent. The present percent of total revenues from estate and gift tax total Federal revenues is only 1.6 percent. If we cut it by 50 per- cent and also compare the other increasing taxes, namely, social se- curity taxes, we may have an estate and gift tax structure producing 0.5 to 0.8 percent of the total revenue. If that is the direction that this committee and Congress is pre- pared to go, I would suggest repealing the entire structure because it is not worth the complexity. The question I ask myself and I ask this comffiittee is to decide at the outset what is the purpose of the estate and gift tax structure. Everybody is jumping into the statute and tinkering around with- out any eye to its purpose. I think this absurd and I think it is an immense omission both by the committee and by the experts who come before the committee. I feel quite deeply about that, obviously. After deciding its objec~ tives I share with many members, including the panel here today~ that we want to be concerned a~bout equitable distribution of the burden. We want to be concerned about efficiency and Mr. Sutherland. and Mr. Cantwell are concerned in terms of the impact of the economy~ and we also want to be concerned particularly in Mr. Sutherland's view with not interfering with a person's personal choices as to the property that he has and how he would like to leave that property t~ his beneficiaries. 1 "Background Materials on Federal Es~tate and Gift Taxation," dated Mar. 8, ~976, letter from Economic Division of Library of Congress, dated Aug. 4, 1975, referring to S. 2187, reported on p. 62. PAGENO="0757" 743 Thecountervailing limitation, of course, is always complexity. How ~many practitioners understand the terms and rules with respect to tIi~ .deductibility of th~ charitable remainder? I woul4 suspect that this committee is going to hear some further comments on the deductibility ~of charitable remainders. I think the committee is also aware of the request for extensions before effectiveness of the charitable remainder. The chart which I include in my statement does indicate that the ~estimated estate and gift tax percentage of total revenues for the year 1977 will only be about 1.6 percent. Lewis Eisenstein said it well 20 years ago: "While it-estate and `gift tax law-helps to support many lawyers, it does relatively little to support the Government." It also amazes me that the amounts of lawyering services and pro- `viding of estate planning, the number of courses in our law schools, number of planning conferences sponsored by the bar association seems somewhat inconsistent when we look at the total relative .revexu~e ~of the estate.and gift taxes. Compare the extent of those efforts and re- `sources expended by the legal community on the present social secur- `ity tax system which produces nearly 30 percent of Federal revenues. Yet the social security tax structure as opposed to estate and gift tax structure is regressive. Why do we lawyers come to speak about estate and gift taxes and we `let one of the worst and most diffic~ilt burdens' that the Government `has, the social security taxes, continue in the form that it is? This country is likely going to face the hard choice with respect ~ social ~security taxes, not in the next decade, but in this decade. That is whether general revenues from income tax will have to be used to sup- port the social security system or we will have to start talking about `a progressive social security tax. I do&t think the structure is an insurance program, it is a tax pro- ~gram which. is going to be dependent upon general revenues of th~ ~Government. ` . . ` I would like to briefly offer my comments as to the purpose of es- tate and gift taxes, Ithink.if you review the history of estate and gift taxes it is clear that this country is not interested, in redistribution of wealth through the `estate nnd gift tax strueturc. Its sole purpose I `think for its continuation and, . yes, even reforms, is revenue, The proposed reforms tl'~'at we have:heard discussed this morning, as I have indicated, would cut, that revenue by .50 percent.' To give you some handles on the relationship of the estate and gift `tax revenue, the tax rebate last, ye~r whei~ everybody received either $200.or $100, eostthe FederalGovernment $S billion. That is more~han' the entire arnoun t of revenue collected by the estate and gift. taxes. If you cut it further we are talking about a revenue perhaps less than th~ eustoms i~eveniie `product in this country.. .` I suspect that the real function of the estate and.gift~tax structure as presently exist~. is to provide the illusiOn to th~ uninformed middle elass that wealthy people pay excessive estate and gift taxes, ari4 the `corollary illusion to the wealthy peOple that they pay an excessive tax on their estates. . . ` ` ` . ` , Perhaps it provides that function as opposed to ~ither proancing revenue or relating to any defined objective or purpose of the Federal ~Government. PAGENO="0758" 744 Being a lawyer, I would like to briefly `indicate my tax tinkering at- titude toward the proposed reforms. One, with respect to increasing the exemption, I think if you do, it ought to be phase out as taxable estates reach $500,000 `and the increase phased out entirely when you reach $1 million. With respect to the valuation of farmlands, we are talking about a. subsidy to farmland owners. We are talking about an errosion in the tax base. We are talking about starting to tax people not on equivalent value but on the basis of the assets that they hold. This suggests, and induces subtlety although for clearly rational purposes, a very im- portant departure from the present estate and gift tax system. I wasn't here in 1924 or 1946 but I am sure former Secretary of the Treasury Andrew Mellon was making much the same aguments that we have now for small farmers and small businessmen. Just substitute the words "business or capital" for "mall farmers and small business- men" and argue that the estate and gift tax will destroy business and will destroy capital. I think the committee ought to be very concerned about going that particular route and unlike some of the Members, both of Congress and of this panel, I am not certain that Congress can write a statute that we practitioners will not be able to invert and use in a perverse way. For example, by providing an exemption on the valuation of farm- land, we may induce investors into a new kind of tax sheltered invest- ment, transfer of cash in a trust for the benefit of minors and invest that cash in farmlands so that when the minors are of age they are holding farmlands for a period of more than 5 years, which may increase the value of farmlands by driving new money into the farmland territory because of the exemption created by the estate tax exemption. I would recommend that we liberalize the installment payout for people who are burdened by excessive estate taxes. I do not support President Ford's proposal of a 5-year moratorium and a 20-year pay- out period. There would be a significant increase in costs in the Gov- ernment to monitor such kind of program and I seriously wonder if the entire tax would in fact be paid. I am in favor of the unified tax structure and I do recommend that the tax not be imposed on the transfer unless the transferor has re- leased all rights in the assets which have been transferred. Any reten- tion of a right such as the voting rights which the Supreme Court ap- proved in the Byi~uni case and by the Tax Court in the Gilmo're case, any retention of rights should delay the transfer tax until they are released. The importance here is that the transferor would perhaps desire to incur the transfer tax at an earlier date while retaining the control over the asset to avoid further tax on the increase in the value at date of death. A number of taxpayers have demonstrated their ability to pervert the structure by a small thing called the annual exclusion. I suggest the annual exclusion be restricted, one, to outright transfers to adults of the property; two, a transfer to a minor only if income and cerpus must be distributed at 18. I don't want to take too much time of the committee and I feel that my time is up, but I think the unlimited marital deduction should he PAGENO="0759" 745 ~llo~al~i~ oni~ up t~ apprøximatély $~0G,0Q0 because at That point there is sufficient income available to provide for the support and main- tenance of. the surviving ~pouse, so that I would not be in favor of unlimited marital deductiOn. With respect to imposition of capital gains tax, income tax at date of death, I think here you have an interesting problem, one I feel that is too complex but, too, people in the higher estate tax bracket would pay less capital gains because under the proposal it is a deduction for the estate so the higher your estate tax bracket, the lower your capital gains tax would be. So that the lower your tax bracket the higher the income tax which would be paid. I am not in favor of the capital gains tax at death but would sug~ gest a flat 10 percent tax, which is not a deduction to the estate, but a cost for the increase in basis of the asset and which represents a minor compromise with a difficult problem. Finally, I would like to suggest that all post death payments to a former wife be deductible and that this Congress enact a new section, sectiou 2043(c) which would provide that transfers pursuant to a sep- aration agreement would constitute adequate consideration and/or such postdeath payments to a former wife would also qualify as a debt under section 2053. There is some litigation in the area and the IRS takes a very hard view with respect to transfers to a former wife. It is hard to conceive that type of transfer as one not for adequate consideration. As concerns liquidity~ I would also recommend that section 302 be revised to allow closely held corporations or businesses to be redeemed if the estate and/or heir sells all of the stock without regard to the problems of sections 303 or 302. I am sorry I took so much time of the committee and I appreciate your forebearance. Mr. BURLIiSON. Thank you very much, Professor Moran. We do have a quorum call we have to answer, Professor. Professor Dodge, if you can be back at 2 o'clock, along with the en- tirepanel, we would appreciate it. Mr. cONABLL Is there any problem about that; do some of you have to leave? Thank you very much. [The prepared statement follows:] -~`~1 STATEMENF OF GaRALD P. ~MORAN, ASSOOtATE P1iOFESS0R, IJNIVrTiSITY OF TOLEDO COLLEG5~ OF LAW Gentlemen, I am pleased to have this opportunity to share my views concern- ing estate and gift tax reforms and my professional experiences in obserring the operation of the present structure, particularly on such a grand date as that of March 17 for a third generation Irish American, ~or approximately seven years, I was employed by the Internal Revenue Serv- ice in several different capacities as estate tax examiner, as a tax law specialist in the 11~xempt Organizations Branch of the Commissioner's Office, and finally as a trial attorney for four years in Regional Counsel's Office; I left government in 1~)7O and entered into private practice where I also specialized In Income and estate tax matters for four awl one half years Presently, I am in my second year of teaching, at the University of Toledo College of Law. Obviously, I speak from the perspective of both government and private practice Thia Committee throughout Its history haa held long and d1~cultiiearings on many tax proposals. I like my predecessors and successors have a deftned set of PAGENO="0760" ~values as tomy personal feelings as to how "ought" the tax structure be n~odifled, if indeed, at all. I do not, of course, represent any views of former clients or groups. As applied to the estate and gift tax structure, the most important question I have of myself and this committee relates to the purpose of the estate and gift tax structure. It amazes me to see how a lawyer's training prepares a man to tinker with a set of statutes without establishing at the outset the underlying objec- tive of those statutes. In what way can we reform a statute without consider- ing its purpose? Apart from that, is there any method to determine whether the present statutes are successful? What are the precise results of the present estate and gift tax structure and why? What do we want to accomplish and how? Unfortunately, either by ignorance or training, lawyers, whether profes- sor or practitioner, jump into the boat without a star for aiding in direction. Assuming a precise objective of the estate and gift tax structure is formulated, then the proposed reforms can be judged from a consideration of the following ~factors: (1) Quality of equitable allocation of the tax burden; (2) Quality of efficiency in allocation of economic resources (clearly such changes should not inhibit economic growth) ; and, (3) Non-interference with an individual's private choices as to the bene- ficiaries of his property. The countervailing limitation as to the enactment of such reforms relate to the resulting complexity, both as to its ability to be administered by the Internal Revenue Service and the public's ability to understand the changes as they affect present wills and trusts without incurring an unreasonable legal cost in respond- ing to such reforms. Many have assumed or recommended reforms without directing sufficient con- sideratiOn as to the purposes of the estate and gift tax structure nor how it re- lates to our total tax policy. Basic reliance on its continuation and reform is posited upon the fact that it may be one of the most important "progressive structures" in our present tax system, But is this progressive feature of the estate and gift tax structure sufficient to support its existence in view of. the nominal revenue it generates? It shocks me to observe that the estate and gift tax revenue has been such a small part of our total revenue. For example, the percentag of estate and gift iax to total revenues for four out of the last six years (19 0 through 1975 in- clusive) has been less than 2% and the estimates of 1.7% for 1976 and 1.6% for 1977 do not disclose a reversal of this ~ltuation. COMPARISON OF TOTAL REVENUE TO ESTATE AND GIFT SHARE 0 REVENUE [In hillionsi / 1970 1971 . 1972 . 1973 1974 1975 1976 `1977 Total revenue $193. 7 $188. 4 $208. 6 $232. 2 $264. 9 $2 0. 9 $297. 5 . $351. 3 Estate and gift tax $3.6 $3.7 $5.4 $4.9 $5.0 4.6 $5. 1 $5.8 ~Estateandgifttaxpercent_... 1.8 1.9 2.6 2.1 1.8 1.6 1.7 1.6 Customs $2. 4 $2. 6 $3. 3 $3. 2 $3. 3 3. 6 . $3. 8 54. 3 Customs percent 1. 2 1. 3 1. 5 1. 3 1. 2 1. 2 1. 3 1. 2 ~SociaI security~.. - $39. . $41. 7 . $46.1. . $54. 9 $65. 9 $ 5, 2 $90. .1 $96. 0 Social security percent 20.2 22. 1 22. 1, 23:6 24.9 26.7 26.9 27. 3 The above clearly discloses that estate and gift tax are not a significant part of~ our total revenues. When one considerS the time and eff~ort of lawyering eerv- lees in providing estate planning, the numerous courSes in our law schools and the increasing number Of planning conferences by Bar Assoc ations, sthne con~ -sideratioñ should be given to the cost and allocation of lawyer!ng serviCes for such a `sniall part of the revenue system. Oompare the exte t of those efforts and resources to those e~cpended~ by the legal community on bhe present social security tax system, which produces nearly 30% of the total fe leral tax revenues of this nation. Yet the Soeial Security tax structure, as opp sed to the estateS ~and gift tax structure, is regressive. This country will ilk ly face the hard I Estimated~ Source: The `Budget of the U.S~ Government. 746 PAGENO="0761" 747 choices of ftndlng social security before the end of this decade-possthly from~ either current income tax tevenues or from the creatIon of a progressive tax rate imposing social securitytax. In any event, it becomes particularly incumbent upon this Committee to set out the objectives of the estate and gift tax and bow the enacted reforms wilL carry out those objectives. ESTATE AND GIFT OBJECTIVES REVENUE? The estate and `gift taxes have never produced significant revenue since its enactment in 1916.' Yet, as the well respected tax economist Joseph A. Pech- man noted, "One can only guess why the estate and gift taxes have not been more'succes~fiil.. A possible explanation is that equalization of the distribution- of wealth by taxation is not yet accepted in the United States."' I believe it is fairly obvious that we do not look to estate and gift taxes as a means to re- distribute wealth. Therefore, its primary purpose simply should be to raise revenue in an equitable and economic fashion. Perhaps another way to demonstrate the insignificance of the revenue of es- tate and gift taxes is to consider the Tax Reduction Act of 1975 and the present propOsals concerning 11.11. 10612 President Ford In his annual message on the State of the Union (January 15, 1975) proposed `a one year tax reduction of 16~ billion dollars which was enacted, with modifications increasing the amount of reduction to 24.8 billion, by this Congress last March 26, 1975. That one year reduction was more than 4.5 times the entire amount collected from estate and gift taxes. The rebate (maximum of ($200) to each taxpayer) cost the U.S. an estimated 8.1 billion dollars. The refund of 1974 taxes, the $50 one time pay- ment to social security recipients, and' temporary Increased unemployment com- pensation cost $10 billion. While the income reduction of 1975 was tied `toward other concerns such as stimulation of the economy in a manner comparable to the" Revenue Act of 1964, there still must be some serious concern as to the total amounts collected. ILR. 10612 which passed the House last year and is pending before the Senate Finance Committee carries the income tax reduction even further into future taxable years. The additional credit allowance proposed for" dependency exemptions to a maximum of $240 (2% of $12,000 of taxable income) will cost $5 billion. This latter amount alone equals the present yield from estate" and gift tax. Need I say more? Perhaps the present "real" function of the system is not collection of revenues- but rather a socio-political compromise that allows the uninformed middle class to believe the rich pay more in estate and gift taxes and the corollary illusion ot the rich that they pay excessive estate and gift taxes. If the amount of estate and gift taxes further decrease, one reasonably would ask this COmmittee whether such continuation and reform is worth the dual cost of (1) dealIng with the complexities inherent in such reform modifications, and (2) the' immense amount of resources that estate and gift taxation and plannl~g corn- mands in our society. While I hesitate to advocate its repeal, I do urge that this Committee consider what increase in revenues from the estate and gift tax structure is reasonable for us to recommend either its continuation or reform. The Treasury Proposals of lOfO did not suggest an increase nor did the former Administration In 1973 when hearings were held before this Committee. A statement by former Secretary George P. Schultz on April 30 1973, is ex- emplary of a very prominent view regarding estate and gift tax revisions: First, we urge that whatever changes are made In estate and gift tax laws, they' be balanced In a way which does not change the overall revenue from these tawe~. (Emphasis added.) There se~rns to b.e it consistent avOidance Of the hard question of the underlylngr purpose o~ the estate and gift tax structure, and a strong resulting proclivity to- ward statutory tinkering with a rather ineffective ta~ `system. SPECIFIC PROrOSALS Being a product of lawyering, training, and tax tinkering, let me offer my views' as to the prop'osals: ` 1 Pecbman, Federal Tax Policy, Brookings InstItute, 187 (1971). PAGENO="0762" 748 1. Increase Ecoen~ptlon This Is a Presidential campaign year. The President and some of the con- tenders, if the course of history runs true, will propose tax reforms which will invite substantial political support for their candidacy. See, e.g., President Ford's State of the Union address on ~January 19 of this year recommending further in- come tax reduction and proposed ". . . estate tax changes so that family busi- nesses and family farms can be handed down from generation to generation without having to be sold to pay taxes." An increase in the estate tax exemption would further weaken the undefined revenue objectives of the estate and g~lft tax structure, as discussed above. If the Committee Is Inclined to support such an increase, I would suggest that the increase be allowable in full for estates having a taxable estate less than $500,000 and then such increase phased out as taxable estates exceed $500,000 to $1,000,000. 2. Valuation of Farm Lands As to farm land exemptions, one can fully appreciate the problem of inflation causing the termination of farming operations which cannot generate sufilcient income to pay estate tax obligations. However, what are the precise figures to support the proposition that many farms are in fact being sold to pay estate taxes? I feel it is importan1~ for the Committee to explore the dimensions of the problem before it enacts specialized relief for valuation of farm lands at less than fair value. Despite the apparent logic and quality of the argument concerning' a special exemption for the valuation of farm land, I am reasonably certain that indi- viduals outside the scope of bona fide objectives of the stai;ute will attempt to qualify under its exceptions. See, e.g., H.R. 1973 providing exemption for farm land, "woodland," or "scenic open spaces." The latter two ideas are wide open for obvious abuse. 3. Instafl'ment Payout for Farmers and Others The proposal to increase time for payout sounds responsive to the needs of those estates which are not sufficiently liquid to pay the tax without incurring economic losses through forced sales. However,, there presently exists a limited procedure for installment payout under Section 6166 of tho Internal Revenue Code. President Ford's proposal of a 5 year moratorium and tijen a 20 year payout of the estate tax liability is staggering. The revenue loss, I suspect, from the delay will be in the millions of dollars and the possibility of the tax never being paid must be considered a possibility. In addition there will be increased governmental cost in monitoring' such a program. The present installment system, if slightly liberalized, should be sufficient. 4. Unified Transfer Taa, Treatment of one transfer tax makes sense, with the ratos being lower and slightly progressive for transfers up to $200,000, with a significant Increase in progressive rates for transfers over $200,000. A maximum ra te of 50% to 60% would be high enough. I also believe the failure to gross up gifts Is a technical omission that should be rectified in the unified rate structure. Any retention by the transferor of an Interest in connection with a transfer should delay the transfer tax to the date of death. Here I speak precisely as to retention of voting rights which under the Supreme Court's view in Byrum and more recently by the Tax Court In Gilmore are not sufficient to cause Inclusion in the gross estate under existing law. It is my view that retention of any rights should delay the transfer tax until death. 5. Annual E~vcZusion It's surprising to observe the quantity of litigation concerning the $3,000 annual exclusion for the gift of a present Interest. I suspect the government and taxpayer alike may he incurring legal fees In excess of the amount of tax in issue. I recoin- mend an annual exclusion only for outright transfers of prcperty to adults. I would recommend an annual excluslou for transfer in trust fo'i- benefit of minors only if "both income and corpus" are required to be distributed to them at majority (now 18 in most states). The creative technIç~ues of brilliant practi- tioners have destroyed the limitations imposed on the qualification for the annual exclusion on many transfers in trust which in substance are transfers of a future interest. PAGENO="0763" 749 6. tJnZimited Marital DeiZ~uotion Many believe there exist substantial reasons to allow au unlimited (100%) marital deduction for outright transfers of property to the surviving spouse, How- ever, an unlimited marital deduction for amounts, for example, of $10 million dollars is completely unjustified. The unlimited spousal transfer should be allow- able only to the extent necessary to have corpus of a sufficient size, so that the income therefrom would be sufficient for the support and maintenance of the surviving spouse. A corpus of $500,000 in most circumstances should be sufficient to accomplish this objective. I would recommend the continuation of the present system concernln~ the allowance of the marital deduction for amounts in excess of $500,000. 7. ctaØtaz Ga4n,~ Tao, in Appreelttion at Death or Transfer Many feel that there Is a serious inequity in allowing assets includiblo in an estate to qualify for a stepped-up tax basis without a corresponding imposition on an income tax. The imposition of an inecnxie tax on ap~reeiat1ou at death would further exacerbate liquidity problems of estates (despite the fact it would be treated as a debt of the estate). I believe the complexity of the reform and the ensuing liquidity problem would be so great so as not to justify enactment of such a proposal. Perhaps I would support a minor flat income tax on the appre- elation In value of assets includible in estates as a cost of the increase in basis. Such tax should not qualify ~s a debt of the estate. I also do not favor income tax realization upon Inter vivos transfers of prop- erty, since such tax would unnecessarily hinder lifetime transfers. Alternatively, if estate and gift taxes were repealed, the complete imposition of an income tax on property transfered by Will or gift would be very reasonable and appropriate. Although estate and gift taxes are different from income taxes, the same "act" resulting in the imposition of two separate taxes Is just too diffl~ cult a burden to support in practice as distinguished from theory. That Is why would recommend a nominal payment (5/10%) for the Increase in tax basis. 8 GeneratIon Skipping Transfers The idea on the basis of equity of imposing a generation tax is outstanding but the procedural statutory delivery is too complex. I suggest there be another flat tax of 5-10% for inter vivos or testimony transfers which constitute genera- Uon skipping devices. I would also suggest a separate generation tax on every trust which fails to distribute its corpus outright every 25 years. The combination of taxing either the donor on a percentage of his rate or an electing deuce would be very difficult to understand for both the public and many practitioners. It invites comparison to the unlimited throwback rules pertaining to accumulated income of a trust. Some are only now understanding the rules concerning deductibility of charitable remainders. 9. Post Death Payments to Former Spouse I believe all post death obligations to former spouses should be deductible by the estate. It is unrealistic to consider transfers of this nature like transfers to a present wife for release of marital rights which are not adequate consideration pursuant to Section 2048(b). I recommend a statute comparable to Section 2510 be enacted as Section 2043 (c), allowing such transfers to be considered. for ade- quate consideration and/or allowed as a deduction as a debt of the estate under Section 2053. 10. Redemption of Stock of Closely Held Corporation Because liquidity is a real concern I would recommend increasing non-taxable redemptions by the estate or heirs of x~on-l1sted stoe~k if (1) all such stock owned by the estate and/or heir is redeemed and (2) the value of such stock is not in excess of 1 million. My concern here Is that the benefits of Section 303 may not be sufficient and the com~iexities of Section 30~»= so great that heirs not interested in participation in a closely held bus1ne~s or an estate in need of cash may not be able to pass a SectIon .302 redemption because of attribution. My recommenda- tion would allow the estate and/or heir to sell all of the stock without fear or concern with respect to Sections 302 or 803. 11. Charitable deduction I recommend continuation of a 100% deduction for outright transfers çf property to qualifying charitable organizations. Depending on changes In the PAGENO="0764" 750 marital deduction, I recommend the charitable deduction `be' applied to reducG the adjusted gross estate for purposes of computing the marital deduction. I see no reason why the marital deduction should be increased by one-half the amounts going to a charity. SUMMARY It is important `to identify the social and economic QbjectiveS of the estate and gift tax structure. The past freely discloses no real intention to redistribute wealth through estate and gift tax. Therefore, the .sole conceru is the issue of what amount of .revenue should ~be coUected through t)~is structure without un- duly interfering with economic investment and savings needed for jnvestment. Most believe that estate and gift taxes have less adverse effects. on incentives and investments than do `income taxes. Except for the situation whereby the family business and/or farm might have to be sold, the principal important quality of such estate and gift taxes is that they arefully progressive taxes im- posed upon those who are reasofiably able to pay the tax. Finally, your experience With the limitation imposed on charitable remainders, and demands for extension of time before such charitable limitation became effective, suggest a modest and slow change in the system. Perhaps the reforms should be phased in over a five year period (particularly those that impose tax). I would specifically grant the Commissioner additionally defined powers to allow for resolution of the transitional problems which are i~ot fully anticipated by the statute and require the Joint Committee to review those decisions which affect a reduction of tax in excess of $100,000. If we add further exemptions and increase deductions without regard to re- sults, we may see within the next 10 years the quiet death of such taxes. On the other hand, a review and sig~iflcant statement as to purpose and method to achieve such objective by this Committee with subsequent adoption by Congress may reverse the current state of dying suspension. A't the present time we lawyers are creating more smoke and discussion than the fiscal fires of estate and gift tax structure deserve. Mr. BIJRLESON. The committee will recess until 2 o'èlodi. [Whereupon, at 12 :15 p.m., the committee recessed,, to reconvene at 2p.m.] AFrERNOON SESSION The CHAIRMAN. The committee will be in order. Because of a quorum call we will recess for 10 minutes and will be right back. [Brief recess taken.] The CHAIRMAN. The committee will he in order, please. I believe Professor Dodge is still here. You may proceed, sir. Mr. CONABLE. Mr. Chairman, I think we should thank the panel for their patience. We are sorry we could not hear from you this morning. Professor Dodge, you have had a chance for reconsideration of your remarks in light of those of your colleagues. STATEMENT OP JOSEPH H. DODGE II Mr. Dor~E. Mr. Chairman and members of the committee, I am very pleased to be able to have the opportunity to testify. It is also very tempting for me to try to comment on everything that has been said this morning. `Nevertheless I will proceed with ~my prepared remarks concerning estate and gift tax reform, which follow the principles of neutrality, equity, and understandability. I use the word understandability instead of simplicity because I am not sure simplicity is completely attainable. Otherwise, it .seems~ that the other panelists seem to be generally favoring the same princi- ples. However, where we go from those principles is another matter. PAGENO="0765" 751 What I mean by neutrality is that a tax law should not unduly in.. fluence the form of family transfers. And by equity I suppose I mean that the wealthy should not be able to escape their fair tax burden. Finally the idea of intelligibility is fairly self-explanatory. People should understand the principles underlying the tax laws. The tax laws, and particularly the estate and gift tax laws, should not be based on concepts of incentives or penalties such as sometimes creep into the income tax area. There is no principle of property evo- lution that I know of that the Federal Government should go out of its way to favor, and at the same time I don't think estate and gift taxes should unduly penalize any particular type of family wealth plan. Nevertheless, our present law in some respects does have effects of penalizing and encouraging certain forms of transfer, I am interested in the entire estate and gift tax reform, but I would like to focus on the two areas of generation skipping transfers and estate and gift tax unification. Turning first to generation-skipping transfers, I would mean by this term transfers in trust which have successive interests, I would not include, therefore, outright transfers to grandchildren. Now there is nothing wrong with generation skipping transfers per se. They might be made for perfectly valid nontax avoidance reasons, but from that assumption I reach the conclusion that they should be taxed b~cause the present structure does not tax them whereas other forms of trausfers are taxed. I don't believe in penalizing such trans- feis. I merely believe they should be treated in as closely an equal fashion as possible in other forms of wealth disposition. Also one aspect1 of generation-skipping transfers is that wealthy persons are peculiarly in a position to take advantage of them. Now I believe that the termination of trust interests, such as life estates, is just as much of a transfer as the kind of transfer that is presently subject to the estate and gift taxes. Such terminations repre~ sent a shift in economic enjoyment from one person to a succeeding generation. The main reason they have not been taxed so far is be- cause of historical accident, and the fact that the estate and gift tax laws to some extent follow the laws of future interests. At th~ same time I would not penalize such transfers in the manner that I believe that the Treasury proposals of 1969 would do. I would not impose atax upon the creation of generation-skipping trusts. To do so would give the appearance of imposing a burden on something that might be made for perfectly legitimate reasons. It seems to me, if we are going to pursue the taxation of generation- skipping transfers, we should impose the tax at the time of the termi- nation of an interest and the concomitant shifting of enjoyment to the next interest. Therefore the tax will be borne by the property it- self which really means the next generation in line. It should not be a tax on the generation that is currently enjoying the property. The most~ common example of a taxation event under this scheme of tax on suc~ cession would be the expiration bf a life estate. Other events which would also be taxable would include the expiration of a term for years, assignment or release of a current enjoyment interest, and also a corpus distribution to another person. Such a corpus distribution would really amount to a transfer away from the person who is presently enjoying the property. PAGENO="0766" 752 It has been said there is going to be a lot of technical difficulties in dealing with discretionary trust. I don't really want to get into that in my oral testimony. The statement I submitted outlines a way of deal- rng with that. There is nothing new about it. You would simply have a formula which is based on actual enjoyment of the trust in the past, The mechanics of such a system, although they might appear to be complex to a certain extent, would not be totally unfamiliar. They would bear a strong remsemblance to the concepts that underlie the income taxation of trusts in subchapter J. However, the proposal would be a lot simpler than subchapter J. You would not have the concept of distributable net income, instead, everything would be based on trust accounting income. Another aspect of the proposal would deal with the problem of suc- cessive taxable events that take place over a short period of time. I think the solution to that problem is to expand the credit of section 2013-that is the credit with respect to prior transfers-or alterna- tively there could be an exclusion based on the same idea. It seems to me such a credit would better embody the idea of a "generation" than would any kind of rule, for example, that exempted transfer skipping one or fewer generations. I do not wish to go into the technical aspects of the generation-skip- ping area any further. Some are set forth in my statement, and I would \j~ willing to assist informally if anybody is interested in it. Now, I would like to turn to the area of estate and gift tax unifica- tion. I am generally in favor of the idea of unifying the structural fea- tures of the estate and gift tax. By that I am referring to the rate and exemption structure. One reason that particularly appeals to me along those lines is that you have an opportunity to abolish section 2035 which is the section that involves transfers in contemplation of death. Litigation under that section is costly and unproductive, particularly unproductive for the government. Nevertheless, whether or not you unify the tax structurally is a kind of policy decision that you are best equipped to make, and I would like to focus on what I would call doctrinal or technical aspects of unification as opposed to the structural aspects. The principles I would follow with respect to doctrinal or technical integration of the estate and gift taxes are three. First of all a person should be taxed on the value of what he trans- fers. Second, any such transfer should be subject to tax only once. And third, in a case where the tax could be imposed either at the time of transfer or at the time of death, I believe that the tax should be im- posed at the later time. Now this is, I guess, contrary to some aspects of the 1969 Treasury proposals which generally favor the imposition of tax at the earlier time. I go along more with the American Bankers Association draft in favoring the tax at the later time for the following reasons. First of all, as a matter of principle I think a transferor should be taxed with respect to the accumulated income and appreciation on property over which, or with respect to which, he still retains control or powers or enjoyment. Second, such third principle, the hard-to- complete rule, is something that you could enact without having struc- tural ttnification. If you still wanted to have a separate rate structure for gifts and transfers at death you could nevertheless attain doctrinal PAGENO="0767" 753 or technical unification by following the hard to complete principle. r1~hird, such principle is generally in accord with present law. Present sections 2036 through 2042 generally embody that policy. What you would be changing would be the gift tax rules which are involved with actuarial computations which are unsatisfactory. Finally I think transfers at death are far easier to enforce. As has already been said by other members of the panel there is a lot of noncompliance with the gift tax. In certain areas people are not even aware of the gift tax, and therefore generally with such transfers I think the administrative fac- tors weigh heavily for taxing it at the later time. I would like to apply those general principles to a couple of specific areas. I would like to first mention life insurance. Life insurance, I be- lieve, is something that should be taxed to the transferor thereof. The amount that should be taxed is the proceeds of life insurance. When a person pays premiums with respect to life insurance what he is in effect doing is transferring the proceeds. I realize that in 1954 you changed the scheme of taxing life insurance, you eliminated the so- called premium payment test under which a pro rata portion of the proceeds was taxed on the basis c~f the portion of the premiums paid by the decedent. Congress repealed the premium payment test in 1954 for perfectly plausible reasons. They wanted to give taxpayers a chance to cut their strings with respect to life insurance just as they could with respect to other property. In addition the premium payment test did not really bear any economic relation to the business facts of life insurance. So now we have complete reliance on section 2042 which is based on an expanded concept of powers. The taxation of life insurance now has no connection at all with the idea of payment premiums. There have recently grown up two problem areas which I believe are directly attributable to the repeal of the premium payment test. One is the area of premiums paid in contemplation of death. There have been cases which have taxed the proceeds under section 2035, but the case law in that area in my opinion is not settled at all. It is an extremely important estate-planning area in which there should be certainty. Anything involving section 2035 should not be the basis of the law in this area because 2035 involves factual questions and also the 3-year cutoff in my opinion is unrealistic when you are talking about insurance. The second problem area involves the situation where an insuror acquires incidents of ownership in a fiduciary capacity. In other areas of the estate tax a pow~r held in a fiduciary capacity would not cause taxation to that person but it does in the life insurance area, or at least there are a bunch of cases in the fifth circuit which partially say that that is the case. I believe that the taxation of life insurance should revert to a con- cept of economic transfer, that is, to the payment of premiums. I would not go back to the premium pay~nent test prior to 1954. I believe there is a distinction between term insurance and other types of insur- ance. With respect to pure term insurance it is really the last person who paid the premiums who transferred, the proceeds. With respect to whole life insurance there is a~ larger bundle of rights and what the person who pays the premiums does is builds up a cash surrender value and to support a pure-insurance element on top of that. PAGENO="0768" 754 What I advocate is a presumption that the proceeds of, insurance would be taxed to the estate of the insured. The insured would be able to rebut that presumption: (a) in the case of pure term insurance, the entire proceeds could be excluded by. showing that `the insurance did not pay the last premium; (b) with respect to whole life insurance, there could be excluded from the insureds estate, the difference be- tween the face amount and the cash surrender value as of the time the insured ceased paying premiums. I do not know if this proposal would result in more or less tax than under present law, but I believe it would create certainty. There are three corollaries to this proposal.' First, all premiums paid with respect to life insurance that has previously been assigned should not be eligible for the present-interest exclusion. I think that it is absurd that premiums on life insurance owned by somebody else should qualify for that exclusion. Such premiums are creating future eco- nomic value. Second, I believe that, in order to avoid any tracing re- quirernents, premiums paid by the spouse of the insured should be deemed to be paid by the insured. Finally, in cases where the insured's `estate could exclude the proceeds or part thereof under the principle already stated, the Government could still include the proceeds in cases that are analogous to a general power of appointment. In other words, the concept of incidents of ownership under section 2042 should be brought into h'armony with the concept of general powers of ap- pointment under section 2041 and instead primary reliance should be placed on the idea of premiums creating the economic value. The CHAIRMAN. Professor, are you almost through with your state- ment? It is a very valuable statement, and extremely helpful, but to be fair to all the other witnesses we must keep some kind of time schedule. Mr. Doooii. I will just say one more thing. In the area of joint ownership I also believe that the best way to deal with the problem of joint ownership is to enact a mandatory `section 2515. In other words, the creation of a joint tenancy would not give rise to tax. I don't believe people are generally aware of pos- sible gift tax implications of the creation of joint tenantry. There- fore, I think they should be taxed at death or upon severance as at present. However, I would favor an unlimited marital deducation, or at least a large marital deduction and that would eliminate the tracing problem that we have under present law. There are lots of o'ther `areas that I would Uke to talk about, but I guess my time is up. Thank you very much for your time, Mr. Chairman. [The prepared statement follows:] STATEMENT OF JOSEPH M. DODGR, UNIVERSITY OF DwrnoIT, ScHooL OF LAW The goals of estate and gift tax reform should be the attainment of equity, neutrality, and intelligibility. The latter term is akin to, but distinct from, the idea of simplicity. Intelligibility here refers to the possibility of the scheme of tax- ing gratuitous transfers being based upon understandable and acceptable prin- ciples. I propose that one such principle be that of substantial ownership, which is familiar in the income tax area from Helvering v. Cliff orf, 309 U.S. 1(1940), and its judicial, `administrative and statutory progeny. It is self-evident that much of estate and gift tax doctrine is based upon own- ership ~nd the transfer thereof The doctrine of substantial ownership has long been the foundation for the estate tax rules in the area of inter-vivos transfers with retained rights, powers, and interests, which are deemed to be testamentary PAGENO="0769" 755 In nature according to Code sections 2086, 2087, 2088~ 2039,~04O, and 2042, In many, but not all, of such cases the transfer is also ~Ieemed. iziecpmplete for gift tax purposes, One of the tasks of reform is, I think, to apply this principle eon- sisteptly in order to eliminate needless overlap between the gift and estate taxes. This task can proceed in the ptesence or,abseziee of the (structural) integration of the rate, base and exemption structure of the two~ta~es. INPEGR~&T1ON In the reform area referred to as integration, the issue, with respect to inter- irivos transfers with retained sttbstautial ownership, is whether to impose the tax at the time of transfer or at death (includir~g~tbe transfer or release of sub- .stantlai~ ownership rights). Under either a unified or dual ta~ system, the revenue gatn~d by subjecting the transfer to tax at the earlier time should approximately equal the additional revenue due to appreciation and accumulated income since the time of gift to be obtained by taxing the same transfer at death. Under the present dual tax system, there are various incentives for effecting completed gifts, but the rub is that the doflor must part with the property. Evidence sug- gests that such incentives have not been ~)1fflcient to induce the effecting of inter-vivos transfers on a widespread basis. since there exist equitable problems, particularly to recipierits,~of ta~cing gifts and bequests differently, such disparity should probably be removed. S1miiariy~ the existehce of incentives in this area violates the principle of neutrality. Said principle is double violated by the rule of section 1014 which provides an incentive br retatning property until death. In any event, the policy factors favoring encouragement of inter-vivos tiansfers do not seem sufficiently weighty In their own right t~ 5u~port implementing the Aame through use `of ~the tax system. Finally, doctrinal unification on a Sys- tematic and thoro~gh~basis l~ achievable if the disparity should be eliminated. Of particularly deshability would be the elimination of section ~85 (transferS in contemplation of death) and its attendant wasteful factual disputes. In sum, I favor structural unification of the gratuitous-transfer taxing scheme. On the doctrinal level, the choice is between an easy~to-eomplete rule, i.e., `hrpose the lax *h~n, the tran~fPr Is made, and the har~4o-eomplete rule, Le., impose the tax whéti the trans±er becomes eomple~ed (wh1~h is usually at the death of th~~donor). I favç~r the bard-to-complete rule. Pirst,~it retains the core `principle of existing estate tax sactlon~,~ `~o, that accumulated administrative and judk~lal interpretation need not be completely t rowa~o~ut. ~ueh core~'inelple, of course, I~ tnat the doitOt' of an in&nn~leted gjft~ shquld be taxed on apprecla- tioii dud, ac~umut~ted income which lie enjoys and/or cqn~tro1s. SecQpd, on the practical side, adOptl~n ~f the hard~to-comp~ete rule `d~es pot 4s~u~e struc- tural u~l~c~tlon, `insofar uS `the Treasury, would generally gain revenue overall with respect ~O this éatego~' of trar~f~r. ThIX4, `there are di~leült1as with the easy- to-eothplete rwe in regar~Wto `jolni-tenanetes and trausfe~; ~f life iusnrap~% Finally, the burden of enforeentent and eoñection seems greatly eased when transfers are taxed at death rather than during `life; the public consciousness of the gift tax seeuis very low, again particularly in the area of joint tenancies and life insurance. My concrete proposals follow; In some respects they follow the 1969 Treasury `and American Law Institute proposals, but they lean more `in the direction of the more recent American Bankers Association draft statute. SF~ØTIO~ 2086(A)(]) Transfers with retained beneficial enjoyment should be Subject to `th~ hard- `to-complete rule. The gift tax treatment of this type of transfer under present law is particularly unwieldy and results in overlap because It adopts a property~ law interest approach involving the use `of actuarial tables. The Idea of retained `enjoyment should be broadened to include actual, as well as "rights" to enjoy~ rnent, The would eliminate problems, such as that posed by Oom,n'r v. Va,n,der WecZe, ~54. ~. 2d S9~ (6th çMr. 1958), where the result may turn on (1) the possibility of, inferring an implied agreement between the grantor~beneficiary' and the trustee of a sprinkle trust or (~2) the status of creditor's rights against `such trust. In addition, the "transfer" apd ¶`retained4nterest" requirements should be `clarified. Cases such as GoOdnow v, Un4ted' ,~totes, ~ F.2d 516 (`ChOl. 1062), and Umted I~Itates v. JJyrum, 4O8 U.S. ~25 (1072), seem misguided insofar as they 68-872-76-49 PAGENO="0770" 756 `reqtilre á~ r~tent1on at the aatne titrie as the transfer. Section 20fl8 does have this requiren1ent~ The transfer requirement should only refer to the fact that the economic source of the property was the decedent and not some other person. The "retention" teqnlrement should he eliminated in its present form; it should suf- flee that the right possessed by the transferor have its source (a) in his own prior act (usually the transfer) or (b) in a property arrangement established by another but knowingly utilized by the transferor (the "empty shell" situation). SECTION 2037 This section is usually triggered by a contingent reversionary interest which expires at the decedent's death. Such an Interest is insubstantial, since It repre~ *sents neither (vicarious) enjoyment nor control. Moreover, since a reversion by operation of law may presently qualify; this section Is a trap for the unwary. At the same time, the application of this ~section involves tOehni~allties that are dif- fleult to understand even for the sophisticated. In short, this section should be eliminated~. Section 2037 currently applies to retained rights to corpus (as opposed to In- come) of a trust. See Estate of Klauber, 34 T.C. 968 (1960). This category of transfer should be subject to section 2086; the problem can be solved by amenth ing said section to~provide that any amounts payable (or actually paid) to a grantor-beneficiary shall be deemed to come first out of trust accounting income. sncTIo]ss 2036 (A) (2) AND 2088 Powers over transferred property should be treated together In one section. r believe that a power to alter, amend or affect beneficiftl enjoyment is a sub- stantiat power, but I would not so characterize a mere power to terminate or affect the time and manner of enjoyment. SECTION 2089 Section 2039 was enacted in 1954 to apply the principles of sections 2036 (and 2037) to (employer) annuities. The problem of integrating the "transfer" (death benefit) and "retah~ed interest" (amounts payable to the decedent) alements was dealt with through the "contract or agreement" device. Compare Montgomerj~ v. Comm'r, 458 F.2d 616 (5th CIr. 1~72) , with Fidelity-RhiZadelphia Trust Co. v. smith, 356 U,S. 874 (1958) (j?rior law), Unfortunately, the contract requirement has often defeated inclusion under seCtiótr 2039. E.g., Estate of Bogley v. United ~9tat~s, 1975-1 U.S.T.C. pam. 13.068 (Ct. Cl. 1975). It seems proper that all einploydê death benefits shotrid be ibcludible where the source of such payments *as the employee's employment status as opposed to the employer's benevolent or charitable Impulse towards the recipient, regard'ess of whetbe~, t~ie employee's rights were non-forfeitable or otherwise vested. ~ECTION 2040 The creation of a joint tenancy is a forni of testamentary transfer with a re- tamed right (to rents) , power (of severance) and interest (contingent reversion). The gift tax treatment of such creation is complex because such rights vary depending on local law and the type of tenancy. Accordingly, section 2515 was enacted in 1954 to treat the creation of such tenancies among spouses with respect to real estate as being incomplete for gift ta~ purposes. This rule would be in effect preserved and expanded under a proposed. un- limited marital deduction, but in other sltuatkns It has been suggested that the creation of a joint tenancy should be taxed one-half when made and one-half upon death. I believe that the principle of section 2515 shOuld be extended to cover all cases. First, it best accords with the notiO~ of substantial ownership; the creator of a joint tenancy has not surrendered much In the way of economic enjoyment or control. Second, it seems arbitrary in this area to urge different rules according to the type of property involved, or whether the joint tenants are spouses. Third, many person probably do not presently comprehend the gift or estate tax implications attendant upon the creation of joint tenancies. The general approach of section 2040 should be retained. If an unlimited marital deduction were enacted, the tracing problem under present section 2040 would become moot with respect t~ :~oint tenancies involving 5pouse~, PAGENO="0771" 5ECTIO~ 2042 With respect to life insurance, Congress in 1954 élithinated the premium- ~aymeiit test, under whiCh the Insured was taxed on that portion of the proceeds as the premiums paid by him bore to all of the premiums paid, even where the insured possessed no incidents of ownership with respect to the policies at lila death. The reason for this change Was to enable an insured, like a trust grantor~ to avoid estate inclusion by cutting the strings with respect to the property. Since 1054, two problem situations have arisen with respect to life insurance (1) a transfer away by the insured of incideuts of ownership followed by the payment of premiums in~ contemplation of death, compare Bel. v. United States~ 452 F.2d 683 (&h Cir. 1971), with Ine~ 0. Coleman, 52 T.C. 921 (1970), and (2> the acquisition by the insured of incidents of ownership but in a fiduciary capaCity, see, e~g, Rose v. U~vited ~tates, 511 F.2d 259 (`5th air. 1975). Both of these j~robiems have inadvertently arisen from the deletion of the premium- payment test, since said deletion elimlnate4 the "transfer" requirement from section 2042 which is present in sections 2086 through 2040 and also in sectiou 2035. I believe that transfers of insurance should prima fade be taxed at death because: (1) insurance is inherently testamentary, (2) the amount transferr&1 * is the face amount, which isgreater then the gift ta~ value, and (3) the mature~1 pol~cy provides a source of funds to pay the transfer tax, Under present law, lnclüdibllity of the proceeds results in some cases pursu~n't to a "transfer" theory *iflider section 2035, without regar~ to section 2042, but! the subjective aspect of that section is undesirable and the three-year cut-off period is arbitrary in thi~ type of situation. A preferred approach, along the lines of section 2040, would `be to presuthe that the face amount is Includible at the insured's death; however, the insured should be permitted to prove that he did not transfer the face amount. For most policy types, the portion not trawiferred by him would be the excess of the face amount over the cash-surrender value at the time the insured ceased paying premiums. (Such cash surrender value, plus premiums paid by the Insured, would have been taxed earlier). In the case of pure term or accident insurance, the result would hinge entirely on who paid the (last) premium which in effect created the entire proceeds.. The foregoing in. effect amounts to a modified "negative" premium-payment test, Life insurance premiums are the economic source of the proceeds, and therefore the proposed scheme is appropriate. Such is not a disguised return to the pre- 1954 premium-payment test; the pro-rata approach of said test bore no relatioi~ to economic or any other reality. Since the identity of the premium-payer is crucial, it would be desirable, to ~adopt a rule wherein payments by the insured's spouse would be deenied to. be by' the insured. Cf. ~ 677(a) (3). On the other hand, under an unlimited marital deduction, the tracing problem would notba that important. The' reverse premium-payment approach r~ould also help to solve the problem where the insured held incidents of Qwflet5b1p~'in a fiduciary, capacity: the pro-. ceeds in such a case would prima fade not ~e inçludible in the insured's estate since he did not pay premiums in bbs personal capacity. This result would be overcome only whene the powers held by the insured were equivalent to those conStituting a general power of appointment. In other words, the enactment of a transfer requiremeuLfor life insurance would suggest a revision of the incidents- of-ownership aspect of section 2042 to accord with the principles of section 2041. Said incidents-of~ownership te~t wouldeotne into play only if the proceeds would be exclusible under the `premium~payment test. 1~AXATION OF 0~NERATIoN-SNjFpI~Q TRANSFERS The present transfer tax system~ contains a g~ap insofar a~ it ~oes, not cover the termination of an Interest of a trust beneflclary which, necessarily' irivolvea the shifting of enjoyment to another. ~`1ii~ gap results from adoption of a basic principle of the law o~ future 1ntere~ts, &e,, the ~ucces~qrJxiterest (or remainder> was transmitted by~ and f~ôm the person creating th~, trust and not the preced- `lug interest. Such doctrine need and should not be controllIng for a system of federal transfer taxation. The arguments against reform in th1~ area, und the replies thereto, follow: First, it j~ s~j~d~that taxing such shifts in enjoyment wou~d entail a radical departure ~ present law. Such argumei~t~has force if preseht law is satisfac- PAGENO="0772" 758 tory. Unfortunately, present law results In significant revenue loss and violates the principles of neutrality and equity. It violates neutrality because there is an . incentive to employ generation~skIpPiflg trusts in order to save death taxes when such is not called for by the family and property situation. As to equity, different members of the ~ "grandchildren'~ generation might ultimately receive varying amounts even though the amounts passing from the ancestor to the "children" generation were equaL Also, wealthy individuals are uniquely able to afford to create such trusts and to subsist on the income of long-term trusts. The second anti-reform argument is that it would be unfair to tax the full value of property where only "part" of it was enjoyed by the preceding Interest. The existence of the substantial ownersip doctrine in `the inter vivoS transfer area is concededly not a compelling r~buttal insofar as there all interests have their source in the same person and the Issue is simply when to Impose the tax rather than whether to Impose it. Nevertheless, substantial ownership con- cepts provide a theory on which the reform may be instituted. Moreover, under present law, a tax is imposed by reason of an unlimited testamentary power of disposition (general power of appointment by Will). It is submitted that current beneficial enjoyment of property is equally or more significant for the parties concerned than a mere power to control future enjoyment. Also, it is of course misleading to speak of a tax apon the current beneficIary; any tax resulting from a reform should be designed to be a tax imposed on the property, by reason of a shifting of enjoyment in the property, borne by the successor interests therein. It Is equally misleading to speak of a reform in this area as being a "penalty" on transfers which ma~ have a legitimate non-tax-avoidance purpose. !the goal, rather, is simply to eliminate the undue tax advantages which such transfers currently entail. Finally, If Congress accepts' the partial-Interest argu- ment, it can enact the reform but with a different rate schedule applicable thereto. I personally would not favor a separate rate schedule, however. Perhaps thu greatest stumbling block to reform is the notion that it would inevitably be unworkable and overly complex. I believe that the Treasury and American Law Tnstitute proposals contain serious flaws of this nature. The problem lies with the following reasoning: (1) generation.skippiflg transfers are bar, (2) this loophole should be plugged, and (3) the best way to do this is * to penalize transfers ii~ this form by impo~ing an additional tax thereon. First of all, ge~eratiou-skipping trusts may be motivated by sound family and property management needs. The problem, rather, is simply the skipping of a tacz' with respect to ~ shifting of enjoyment. Secondly, it is Inappropriate to Introdiu~e the concept of penalties and disincentives into the estate tax area. There is no reason to penalize something which is not demonstrably harmful to the economy or society, and even if such harm could be shown I would not favor using the tax system In the first Instance to remedy it. Thirdly, there is no reason to tax outright generation-skipping transfers: an additional tax on the same would create Inequities among different donees depending on their rela- tIonship to the donor. There are further equitable and technical problems raised by this type of approach which Tabali only list: 1) d~flnIng what constitutes a skipped generation, 2) the possibility of exempting from the additional tax skips of one generation (an Idea which I find totally illogical), 3) computing the additional tax on the basis of arbitrary assumptions, and 4) the provision of elections whose mechanics are complex and whose ramifications are obsure. The substantial ownership concept provides, I think, an intelligible basis for dealing with the generation-skipping problem. A tax would be imposed by refi- son of a shifting of enjoyment away from a current beneficiary by reason of death, expiration of a specified period, transfer, forfeiture, corpus distribution, or whatever. Current enjoyment would be defined as a right to current enjoy- ment or actual enjoyment, whichever yields the greater amount. (This modifica- tion could also, be plugged. into a revised section 2036). The concept of actual enjoyment is required to deal with discretionary trusts: the amount subject to tax would be that portion of the corpus which the income of the trust paid or payable to the beneficiary bears to the entire income of the trust. * The foregoing formula entails certain technical rules: F1irst, "Income" refers to trust accounting income. Second, all distributions and psyments should be deemed to be first out of trust accounting income, then out of accumulated trust accounting income, and finally out of corpus. Third, the numerator and denomi- nator of the fraction could for the sake of record-keeping be computed on the basis of a relevant period, such as the period up to and including the terminetlon event measured from the beginning of the (e.g.) tenth preceding full truat PAGENO="0773" 759 aeeoumting sear. These rules would eonceptualiy resemble some aspects of S~b~ chapter ;r t~t~t with far fewer tee~nica1 difflenittes ~`ermanent a~cuuiuUttiOns could a~o1d tax under this proposal I believe how ever that the problem of accumulations is overiated since (1) accumulatIons (except in the case o1~ minors) d~ not normally serve famil~V purposes and (2) the income tax throwback rules severely limit their appeal In any event, dis tributions of accumuLated Income would enter into the numerator of the fraction Also accumulations to which a beneficiary has a vested right could be con sidered as having been paid to him If accumulation trusts become widely utilized a~ a tay avoidance device Congress can deal with it separately perhaps by imposing an income surtax. Other technical matters which can be adequately dealt with are listed below 1. Separate annuities and accumulation trust arrangements by a settlor or decedent would be combined on an objective basis. 2 Trusts with low income yields which are similar economically to aecumu lation trusts, would be heavily ta~ed under this proposal To compensate if such is thought desirable the denominator of the fraction could be defined a'~ (e g) five percent of the corpus rather than actual trust accounting income 3 Distributions in excess of current and accumulated income would be treated to the extent thereof as a prorata termination for all current beneficiaries 4. The problem of over-taxing the trust upon the terihination of interests In close temporal succession can and should be dealt with by liberalizing section 2013 to better accord with the idea of a generation. 5 The tax should prsnia fac~e be borne by the property and hence the suc cessors in interest thereto, unless otherwise apportioned. The fact that tax avoidance devices might conceivably be developed In the future is no reason to withhold reform presently: Congress can anticipate some such devices and deal with others If and when they arise Significant complexity would evolve mainly with respect to the unusual situations, the more common ones would be treated with relative simplicity and on a comprehensible basis. [Additional material submitted by Professor Do4ge has been re- tained in the committee files 1 The CHAIRMAN. Professor, I will say that your document is ex- tremely valuable. You have a great deal of expertise. We will be study- ing it' carefully, and if we do feel we need an expansion of any of your ideas we will be in touch with you again. Do you have any further statements to make? Mr SUTJTRRLAND I have this to say There was a suggestion made by one of `the panelists that the provisions for completely unlimited tax free transfers between spouses might not be desirable and that when an' estate reaches a certain size there should be some limit on the amount. transferable tax free. That would do much to destroy the simplicity which I am seeking. My suggestion was made purely for simplicity and to prevent the necessity of bookkeeping between husband and wife, which is something the law should not require. The taxes involved are not sufficient to require a limitation. It may be said, in addition, that in very large estates self interest could generally be counted upon to deter transfer of much more than half of the total estate from one spouse to `the other. If after you adopt this simple proposal it develops that there are areas where there is any substantial avoidance of tax that the com~ mittee might consider undesirable, it could adopt any amendments considered proper. Certainly the simple provision for an exploratory period would not reduce revenue in any significant amount. I would hope that if this simple nonsubstantive change, as to the wisdom of which there is general agreement, could he'separated out and cnncklv odopted it min~ht set a precedent leading t~ the prompt adop- tion of other simplifications in the tax code, i~s to the r~eed for which there is general agreement, without the delay necessarily invoh7ed ill PAGENO="0774" 700, adopting such simplifications where proposals for tl~eir adoption are; joined with, and required to wa~it upon, enactment of. provisions as to which there is no general agreement and which may, and often do require years of debate. The CHAIIRMAN. Thank you for the further clarifi~ation. Mr. M.elvoin, did you have something to add? Mr. MELV0IN. Mr. Chairman, during the luncheon break the mem- bers of this panel, who had not met earlier, had a chanc~to compare notes and asked me to say we are in general agreement on the principle that unified the Chicago Bar Association Committee on Federal Taxa- tion regarding the need for simplicity and stability and certainty in this area of the tax law. I was asked to go further and. remind this committee of the dilemma that occurred in 1969 when, through the passage of tirn~, we did not have an opportunity to share our experience in the field with yours in the drafting of the statute. It led to a very difficult problem. In this case we think largely of the straitjacket created by the charitable remainder annuity trusts and unit-trusts. There are ~always three steps involved when new law is adopted-first, educating the lawyers, the certified public accountar~ts, the trust officers, and the insurance counselors, regarding the changes in the law. Second, the client has to come in to talk with his adviser before the t~hird step can be taken, namely revising the document. We see in the field documents being writen today that still provide an income to the indFvidual for life with the assets remaining at death going to charity. Your committee knOws that not a dime of that gift qualifies for the charitable deduction, and you just reported out 2 weeks ago H.R. 9889 extending for an additional 2~year period the time within which to cure such documents. We see this and say to your committee in ours experience you must go slowly in this area. We may not like it, but it is a fact. Thank you very much.. The CHAIRMAN, We very much appreciate youradditionai views. Mr. CANPWELIJ. Mr. Chairman, if I may comment~1 would like to underscore the offer of my organization which has people ready in each of the 50 States to make reactions to the local law and probate law effect of proposed transactions and to furnish them to your committee, and that is the principle service we would like to volunteer for you. If I may for one more moment, speaking only; as an individual, align myself very firmly with Mr. Sutherland's point of view. In over 25 years of practicing exclusively estate planning and ad- ministration law, I would say that there is no single prolem-and I think it is in the 50 to 60 percent area-that has given me more trouble than husband and wife transfer made by them without any advance awareness of the fact that gifts were beins~ made, and my difficulties in advising them of the requirements regarding gift tax filing. I couple that with the fact that if they go to some other practitioner who did not do that, or who flaunted that particular state of the law, they probably would have been better off and would not have had to pay those ~rift taxes. I think that is inequitable law that is incapable of equitable enforcement. Mr. Sutherland, if we could get your proposal enacted, it would save half the trouble I have in the planning of estates involving husbands and wives. PAGENO="0775" 761 1 believe Mr. Sutheriand'~ pi~Qppsa1witi~ appy~p~iate safegnards is. much called for in an area where the~ transaot~ons are occurrnig at this minute within a stone's throw of whexe we sit+ Thank you. The CHAIRMAN., The proposals have been exceecilingly ~eipful. Thank you. Mr. MORAN, I would like to. reiterate the principle point of my testi- mony That is I think it is incumbent on this committee and Congress to define the purpose of estate and gift tax structure because it is only by defining the purpose that you can evaluate the reforms. The re- forms which have been discussed this morning for farms and increase in the exemption to $200,000 result in a cut of 50 percent of the total, revenues presently generated by the estate and gift tax structure. If we go that route, Mr. Chairman, I would recommend repeal, and then imposition of jncome tax on the appreciation of property at death, but to further continue a complex structure for minimum revenue~n terms of total revenue needs, I don't think it is justified other than the beneflfs that we have already derived from such a structure. The CHAIRMAN. Thank you. Mr. STErnER. I will be very brief beeause.the hour is late. This panel and the other panels have been very patient. Would the other members of the panel comment ox~ Professor Moran's view of the purpose of the estate and gift tax? Do you agree with what he said? Mr. CANTW1~LIJ. I would agree that it would serve our progress mightily if we were able to know that this point that he made this morning-that this is a ievenue raising measure and not an anti- dynastic measure which was actually the policy of the Congress of the United States. I am in doubt-notwithstanding what the record says- I am very much in doubt. If it is a revenue raising measure I don't have any trouble with that I don't have any clients who are not willing to pay theirf air share of the revenue If it is an antidynastic measure it raises severe questions about policy, about structure, and about everything else. I would like to believe it is a revenue raising measure I think it could be a much improved revenue raising measure Neither I or my clients are afraid of paying th'~t revenue, and they are piepared for it, and I am helping them prepare for it, but that it be antidynastic gives me very serious underlying policy questions about what ought to be the law. Th'at is my point of view, Mr. Steiger. Mr. Donc~a. I don't know if.I would put it in terms of revenue versus antidynastic purpose, but I do believe that the estate and gift taxes are potentiallythe most progressive taxes and I would notlikO Ito see them seriously weakened for that reason. Therefore, I am `not inclined to favor the proposal to increase the exemption. I look with alarm at the erosion of progressive taxes and the building up of regressive t'ixes such as the soc~al secui~ity tax. Mr. MELVOIN. I think `we would emphasize that certainty in this area has such value that even the act of excessive period review of the area, simply to determine whether the existing system should co~itinue is itself disruptive of certainty. Accordingly, I don't think your committee should feel apologetic, having made a review, to come down hard and firm on the point that the PAGENO="0776" 762 system may weU deserve to continue in its present form, particularly if you conclude that there would be a risk of dislocating legitimate planning involved in a proposal having as its purpose not the ~raising of revenue, but the redistribution of wealth. If you were to conclude that, you might well conclude no change should be made. Mr. STRIGER. I appreciate those comments. Mr. Cantwell's organiza- tion includes, Mr. Chairman, a representative from Wisconsin, Chuck Nolan of Oshkosh in my district, and Ernie Schwartz is very active both in the American Bar Association and with what all of you were doing. Both of them have been exceedingly valuable to me in looking at 1~his issue. Mr. BURLE50N. Will the gentleman yield? Actually I have never thought there was a real contention or serious argument that this was not for distribution of wealth. I can't conceive of it being anything else, and I thought the whole history of the concept from the beginning showed it wa~ really for that purpose. I don't have a question. I was just commenting. My own views are so fixed I can't see beyond that philosophical question. Mr. STEIGER. That is what we are going to have to talk a little about within this committee. The CHAIRMAN. Would the gentleman yield? If we have to decide that issue we will spend all of our time debating the issue and never get a bill out of committee so perhaps you are trying to confound us, Professor, by throwing us a curve, but there, is no way we can make that judgment and get language that would eatisfy the members of this committee or the Congress, or that we could get through Congress. Mr. MORAN. With all due respect, Mr. Chairman,how can you reform a stucture when you don't define its purpose. We lawyers by training `are prepared to jump in and tamper, tinker with tax statutes without regard to the objective of the statute and I think that the testimony which most of us will offer is in that direction. We are tinkerers by trade. The CHAIRMAN. Professor, but is there a statement of purpose in the existing law, and I would say no, there is mass confusion as to ~vhat it is all about. There is a burden on this committee to provide equity. Whether there is a statement of purpose, or whether there is not, to provide better equity in the code is one of our responsibilities, and it seems to me it is our charge to provide better equity and to revise to meet current situations, to take into consideration things like inflation and other impacts on the people of this country, and to do it reasonably and intelligently, `and try to figure out what it is all about because I `don't think anybody who wrote the code ever really defined Mr. MELV0IN. Mr. Chairman, I would only emphasize this what we have learned in our experience is that your committee ought not rec~ onimend the adoption of any legislative solution-worthy as it may' appear in `theory-if you believe or even a large group believes that it will have the effect of discouraging legitimate planning unless it is `an essential ~nd major improvement `a~r~~.d unon by a substantial majority. Simply to go with what one small group decides is an im- PAGENO="0777" 763 provem~tit, as the Professor pointed out,~ is' susceptible to many inter- pretations. The CIIAniMAN. Certainly we would not take that route. We are not going to take the route of any narrow group. What we are doing is looking to the whole code, and hopefully examining all of the abuses and inequities that have crept into the proceedings and try and refashion the procedures and the impact in a way that will apply more equitably. NOw, hopefully, our bill can have a negative revenue impact. I have already stated that to be my purpose. I am not positive we can achieve that I doubt we can get that kind of measure through the Congress, but I think that we could do some very intelligent revision, simplifica- tion of procedures, reestabli~hment of equities, within the code with~ out a revenue impact. Do you disagree with that? Mr. MELVOIN. If I understand the chairman correctly, you can cure some problems in the code but if you are talkixig about some simplistic solutions that carry substantial price, tags our concern is that your effort to arrive at no change in net revenue may lead you to create so complex a solution to generate~ tax in another area that you have the dual disadvantage-you are introducing new law, new dislocations, new instability into this system. You have not raised any additional revenue-which refers back to the professor's concern- and you may well be hurting the very group you sought to benefit in the first instance as was discussed this morning. The CHAIRMAN. We appreciate the warning, and certainly it will not be our intention to add any measure of complexity. Mr. FRENZEL. Mr. Chairman, Mr. Eafalis, who was present this morning, wanted me to ask Mr. MeGinty if he included in his recoin- mendation incorporated farms and ranches as well as those held in proprietorship. Mr. McGiwr~. It seems to me that we really have to focus here on the purpose of this legislation, and I think the purpose of it is, at least in my view, to preserve these agricultural and open space lands, first, and only secondarily to help the individuals who are in the position of now owning such lands to be able to retain them. In other words, first we are talking about ~ macrosocial purpose, and second we are talking about a social purpose on a smaller scale Presently many of these farms and agricultural lands are in corpora~ tions These are family corporations There is no employment of the corporation to frustrate the revenue laws It ]S simply an easy method `of holding an .agri~ultural business, facilitating the making of trans- fers of small interests from generation to generation during lifetime withont ,affecting real estate titles and so on. I see no reason to exclude the family corporate farm from any legislation to help the unmcor- porated family farm. The CHAIRMAN. Thank you `very much.' We appreciate your ~a- tience. Mr. Gineows. May I welcome Mr. McGinty here. He is a constitu- ent of mine, or I have the privilege of representing that area in which he resides. PAGENO="0778" 764 T regret I was not here for your direct testimony. I am engaged in a num~ber of other activities right now, but I look forward to dis- cussing it with you. Mr. MCGINTY. I understand, and thank you for your consideration. The CHAIRMAN. Thank you again. You have been very helpful to the committee. [Mr. Cantwell subsequently submitted the following:] STATEMENT OF WILLIAM P. CANTWJSLL, DENVER, COLORADO, INDIVIDUALLY, IN AMPLIFICATION or TESTIMONY ON ESTATE AND GIFT TAX EE~?OEM, WEDNESDAY, MARCH 17, 1976 On Wednesday, March 17, 1970, at the conclusion of the testimony of the panel on which I was afforded the opportunity to testify in my capacity as President of the American College of Probate Counsel, I stated, according to the transcript furnished to me: "If I may for one more moment, speaking only as an Individual, align my- self very firmly with Mr. Sutberlands's point of view. "In over 25 years of practicing exclusively estate planning and administra- tion law, I would say that there is no single problem-and I think it is in the 50 to 60 percent area-that has given me more trouble than husband and wife transfers made by them without any advance a~vareness of the fact that gifts were being made, and my difficulty in advising them of the requirements regarding gift tax filing. "I couple that with the fact that if they go to some other practitioner who did not do that, or who flaunted that particular state of the law, they probably would have been better off and would not have had to pay those gift taxes. I think that is inequitable law that is incapable of equitable enforcement. "I believe Mr. Sutherland's proposal with appropriate safeguards is much called for in an area where these transactions are occurring at this minute within a stone's throw of where we sit." (Emphasis supplied) The following material Is submitted at this time, as an individual, In ampli. fication and support of that testimoliy. A PROPOSAL FOR ALTEB&TION OF THE FEDERAL GIFT AND ESTATE TAXATION SYSTEM FOR PROPERTY INTERESTS HELD BY MARRIED COUPLES, PARTICULARLY IN JOINT TENANCY OR TENANCY BY THE ENTIRETIES Property Law Conoepta Two of the most widely used forms of intramarital property ownership are joint tenancies and tenancies by the entireties (usually referred to in this text collectively as "joint tenancies" or "joint , The single most dis~ tinguishing characteristic of a joint tenancy is its "survivorship" feature. Upon the death of one spouse the title (and full ownership) of a jointly held asset passes to the surviving spouse. This right of the survivor to the property Is not generally affected by the decedent's will, other testamentary documents, or by laws relating to intestacy. On its surface, this form of ownership appears to carry into reality a typical and normal intrarnarital attitude that "what is mine is yours." The apparent simplicity and the perceived normality of the arrangement act to- gether as a running tide and lead many spouses to blind and unsophisticated ownership of their property in joint tenancy. When the blindness is cured, what can be seen is a tangled and confusing web of potentially disastrous tax results and frustrated dispositive desires. The pity is that what starts out as a legitimate quest for a symbolic "oneness" in ownership of the marital pro- perty ends as an almost infinitely complex pattern of results at cross purposes with those sought. No sinister acts or motives bring this about-it derives from the application of little-known provisions of the federal gift and estate tax laws. Seldom is a responsible canvass of these laws made on creation of a joint tenancy, At a later date, often accidentally, the consequences are studied and reviewed and by then the entrapment is apparent, The basic position put for- ward here Is that such a frequent and regrettable series of events derives from PAGENO="0779" 765 an 1rratl~nal and little enforced stkttitory "~abte~ti. which can and should be altered tO remove fro~n the arena of tax-entrapment interspo'usal acts of a widespread nature which currently run afoul of an unduly complex and little. known area of the law for which no sensible enforcement mechanism exists or has ever been conceived. Gift Tctcøation of Jointiy~Owned Propertle~8 The federal gift tax comes into play In two aspects of joint ownership: Its creation and its termination during life. Creation.-Wben peysonal property (other than joint bank accounts and co- ownership government securities) is purchased or transferred into joint own- ership, a gift occurs for federal gift tax purposes in many cases, The question of gift or no gift is d~ter~tnined by the source of funds used to purchase the property. A gift is made when one spouse contributes disproportionately to the Interest he or she receives. For example, assume Dr. Mary receives her share of profits of $25,000 from her professional corporation and decides to, invest the money in the stock market. When the family broker arranges the purchase, it is most likely that he will recommend, or perhaps decide without consultation, that the stock be titled in the names of John and Mary as "joint tenants with right of survivorship" or a functional equivalent creating a "joint tenancy." For normal and usual interspousal reasons, this will, in all likelihood, be the form of title. At this point, Mary has made a gift `to John of $12,500. This is because Mary provided all of the funds for the purchase but received a state law property Interest in only one-half of the assets.1 Real property purchased prior to January 1, 1955 was treated In a similar' manner. T'o reduce the inadvertent gifts so frequently~ made in the acquisition of realty owned by married couples, Internal Revenue Code Section 2515 was adopted in 1954. This Section provides that no gift is made upon the creation of, ~n Interspousal joint tenancy In real property unless treatment as a gift is affigmatively elected on a timely gift tax return. In other words, without the election the spouses own the real property in proportion to their contributiona for federal gift tax purposes. However, by filing a timely election the spouse who . contributes more than his or her proportionate share may treat the crea- tion as a gift to the spouse contributing less than his or her proportionate share. ` The jointly-held bank account Sand co-ownership government security present still another complication of the joint property mystique, Here `there is no gift tax on creation as such, but withdrawal of more than one's own contribution without accountability for such withdrawal is a taxable event. There are thus three sets of variables on gift taxation at creation for the married couple to bear in mind. Acquisition of stocks, bonds, and all property. except real estate, bank accounts, and co-ownership government securities re- sults in `a gift without any other action than acquisition In joint form if the' purchase was not made `with funds "owned" in the same proportion as the property interest acquired. Real estate results in no gift on the same facts, but it ca.n~ be a gift if affirmative action, is taken. Bank accounts and co-owner-. ship gov~rnment securities result in no gift at creation but may result in a gift if a' noncon~ributed amount is withdrawn without aëcountabilIty. This Is just the' be~inning, but John and Mary can be forgiven If they are already con- fused! Termi~~~ation.-The second time John and Mary m~y run afoul of the gift tax laws is upon termination of a joint tenancy during' life. For personal property and~r.ea1 property acquired prior to 1954, a gift occurs when one spouse receives. more .thafi his pro rata (one-half) share of the property held in joint tenancy, without regard to contribution. For joint bank accounts and co-ownership gov- ernment securities, a withdrawal in excess of contribution without accounta- bility operates as a termination `as to those assets and a gift to the withdraw- ing spouse. For tenancies by the entireties, a gift occurs If one spouse receives more than his actuarially-determined interest. For real property acquired after 1954 as to which no election was filed, a gift occurs if the spOuses do not divide the proceeds on the basis of t$lr original contributions. 1 In tenancy by the entireties situations, because neither spouse alone can terminate the tenancy, the actual proportionate property interests are determined by reference to actuarial tables so that the gift would not be of exact! atlons w1~ere the tables yielded such a result. y one-half except in those few situ. PAGENO="0780" 766 ~73Jst ate Thax~tion of Jofntly-Owaed Propertfes rfhe scheme for taxing jointly-owned properties upon the death of either ~spotise has some surface aspects of rationality, but is an administrative disaster ~area for the taxpayer. At the death of the first spouse, there is included in his estate subject to tax the value of the jointly-held properties proportionate to his or her contribution to the cost of acquisition. For example, if John died owning $200,000 worth of stock in joint tenancy with Mary and If John had provided all the funds to purchase the stock, the entire value of the stock is included in his gross estate for federal tax purposes. This is true even if a gift occurred upon the creation of the joint tenancy, althcnigh any gift tax paid upon the creation of the joint tenancy may be applied as a credit against the estate tax. Suppose, on the other hand, that Mary had worked and that her efforts resulted in a contribution to the cost of the stock. Value proportionate to that contribution can be excluded from John's grom estate. Yet to achieve *that result, John's executor faces a monumental task, and he is specifically given the burden of proof. To discharge it he must "trace" the respective con- tributions of John and Mary to the cost of acquIring the property in question. In many instances, this may involve looking back 10, 20, 30, or more years. Needless to say, it is often impossible to trace with even a semblance of accu- racy because these types of records rarely exist and few memories are ac- curate over such a period. For example, assume that a deceased Jèhn and his surviving Mary purchased 100 shares of XYZ stock in joint tenancy in 1940 for $2,000. To the best of her recollection, Mary believes that this $2,000 came primarily from John's salary but that she contributed $500 from her savings prior to the marriage. She is justifiably vague about this, however, and has no records of any kind to substantiate it. Through a prudent sale of this stock and investment of the proceeds in various stocks, John and Mary had $200,000 worth of stock in joint tenancy at his death. Mary's $500 now prorates to $50,000 and John's $1,500 to $150,000. However, all of the $200,000 is Included in John's gross estate because Mary cannot prove she contributed $500 to the purchase price of the original stock. Such is the consequence of an inability to "trace" an event that occurred 35 years earlier-hardly a rational aspect of a taxation scheme. This inability to "trace" the contributions is a result of the same inter. spousal attitude which created the joint tenancy. John and Mary quite typically tended to view their assets as "ours" and it would have been inconsistent-a veritable breach of faith-to document the source of funds used to purchase property. In the previous example, that attitude would cost John's estate in estate taxes from little up to the full marginal rate, depending on other yariables. The tracing requirement, under penalty of potentially heavy taxation if It cannot be done, adds another complex rule for John and Mary. In practice they are virtually never aware of it at the time the crucial acts are occurring, gIld consequently almost never prepared to meet it. Even a sophisticated and studied couple preparing affirmatively to meet the burden would have a monu- mental task. The record keeping would be interminable-a virtual career of ~premortem planning, for the records would have virtually no other use than in establishing the estate taxes in the first decedent's estate. state Law Inoo'n,s'istencies Both the federal gift tax and estate tax laws tend to run Inconsistently with state law concepts of the ownership of joint tenancy property. In a true joint tenancy, either individual is able to terminate the joint tenaitcy by a conveyance to a third party. The third party will be deemed to receive his por- tion of the asset as a tenant in common with the remaining original joint tenant. Thus, there is an "ownership" right in each joint tenant sufficient to support a transfer of that joint tenant's fractional ownership to a third party under state law. It exists without regard to how the interest was acquired, whether by gift or for consideration. There is, however, no such "ownership" for pur- poses of the federal estate tax if the particular joint tenant acquired his right by gift, or is unable to "trace" contributions which may have been made to the acquisition cost. PAGENO="0781" 767 A. tenaucy b~ the entireties shows sople differences here, for no conveyance by either of the tenauts by the entireties Is 1~k~ient to transfer title in the absence of a joinder in the COnveyance by the other tenant. There are additional problems and differenCes with state laws, such as rights to income, rights to encumber, rights of cré4it~ors, state gift and inheritance tax laws, and a host of varIables. To compound confusion there is also the problem of the comming1i~ig of joint tenancy property concepts with community property concepts, and the inevitable variances among the community property juris- dictions in dealing wjth this dilemma. As a consensus matter, however, this disCussion assumes that the heavy majority of states recognizes that each joint tenant does in fact have a property right, and that it extends to a pro rata lhare of the underlying property-4.e., two joint tenants-each owns, a one-half interest; three-each owns one-third, etc. While it is less clear in entireties situations, it is also assumed that there is a state law recognition of a property right in each spouse, but its quantifica- tion Is based on an actuarial computation rather than on a simple proration as in the joint tenancy situations, While it is acknowledged that federal law need not be bound by state law concepts, It is nevertheless urged that the more numerous the differences, the more confusion for the taxpayer. The position urged here Is that there are few areas of common experience for U.S. taxpayers which are more confusing than the joint property area and that such confusion, largely based on taxation statutes, is irrational and counter-productive and should be eliminated. Problems with the Ea~i sting Federal Estate and Gift Tacv Dreatment The efficiency of a tax system can properly be tested by its effectiveness in revenue raising and by its administrative enforcement and equitable application. It is submitted that the federal estate and gift tax system of interspousal acquisition, ownership, and disposition of jointly-owned property is defective on all of these counts. .~eDenae Ralsl~vg.-The adoption of Code SectIon 2515 in. 1954 appears to have been a clear recognition of the ineffectiveness of the joint-tenancy provisions to raise revenue by the federal gift tax. Certainly husband-wife ownership of realty is a significant economic event-for most couples the most significant lifetime aceuuiulation of capital they make. If the release of the revenue from so wide- spread a taxable event was justified-presumably because of widespread non- compliance-certainly retention of the balance of the scheme can raise little revenue. The matter of compliance and enforcement is interrelated with revenue raising, and those points are separately discussed. In final analysis, it Is certainly not the revenue burden on the taxpayer that is at the heart of the jointly-held property problem. A scbeme~ of taxation of such property raising identical or greater revenue should be fully acceptable If it could )~e fairly administered ai~d enforced and if It was capable of equitable application to all taxpayers in functionally equivalent situations. While actual revenue statistics are not known t~ this writer, he suspects that they are not great, at least in the joint tenancy gift tax area, and that the other deficiencies in the system far outweigh the~revenue involved. Adm'tnistration.-T here' are, thorny and difficult aspects of the system which present abnormally conii~llcated administration problems. Many of the elements are subjective. Others ~%epend on less than satisfactory evidence. Still others are subject to no mechanism for vertification. A subjective element is the "inadvertent gift." What happens when the consequences of a transaction under the statute characterize it as a "gift" and no action of any kind is ~takCn because there is nO knowledge of the provisions of the statute? is intent a factor? Should it be? How is Intent formulated subsequent tO a transaction to be interpreted? (Many practictioners suggest that arguments be advanced that John and Mary `had a "partnership" in a farm or ra~eh or business even though nothing consistent with a partnership ever occurred `cOntemporaneously with a series of acquisitions in joint form. The formulation of that intent would be after the fact. Should it control?) No one who has ever endeavored to "trace" can be satisfied that there Is ade- quate bard evidence available, Gaining the evidence that Is available is ex- pensive, time-consuming, and subject to abuses, oversights, and conflicts. An absence of. evidence, or even a casual recollection, can lOad to Inequities. PAGENO="0782" 768 What machinery for detection and verification exists with personal property ncquisitions? Joint account withdrawals? Billions of dollars In stocks and bonds and bank accounts exist in joint form without any administrative mecha- nism to trigger the filing of necessary gU~t tax returns. Who does "own" the reservoir of funds In a joint bank account to which each membOr of a married couple contributes from separate and similarly compensated employment? How can such respective "ownership" be verified? In~ point of fact, most "tracing" proceeds on the basis of determining the existence of a ratio of ownership in ~such a reservoir, followed by imputing a supposed usage of funds in that ratio ~to acquisition of an asset. That is a patently inaccurate process, based on sup~ ~positions indulged in only for tax purposes. The fact is that the commiilgllng was perceived of as making the funds "ours" with discrete ownership aban- doned in the process. Flnforcement.-Enforcement is the ot1~ier side pf the administration coin. It is one of the truly weak links in the joint tenancy tax system. Realization of income is subject to a series of objectively vertifiable evi- dences-chief among them being the withholding system and the information return. Likewise, estate taxation coexists with the probate system, long-estab- lished doctrines of fiduciary responsibility, an abundance of professional corpo- rate fiduciaries, and widespread pubilcity through insurance companies, banks, brokerage firms, and even popular magazines of the existence of the tax. The gift tax, and particularly the possible occurrence of a taxable event on the acquisition of jointly-held property by a married couple, has little in the way of analogous pressures and mechanisms to make enforcement easier. There is no alerting signal when joint property is acquired as there is in the income tax area, for example, when withholding information is filed. And ~hile news- papers and television are filled with advertisements for Income tax services and "tax tips" from preparers, the kind of information available on the gift tax consequences of joint tenancy acquisitions is often misinformation. Indeed, much of the problem may very well stem from an extraordinary level of dissemina- tion of misinformation in the area. How many inadvertent gU~ts (unreported as well) have occurred from advice on title holding given to a married couple by a stock broker, realtor, banker, or car salesman (indeed, by an ill-informed lawyer or accountant)? "Everybody takes it in `joint'" goes the homily, and John proceeds to open a joint brokerage account, acquire stocks in joint tenancy, buy the house in joint tenancy, open a joint bank account, and buy the ear in joint tenancy, because "everybody" must know what they are doing. If this is occurring on a wholesale basis, there are inadvertent gifts being made, yet no system of reliable detection and enforcejnent exists. The sophis- ticated citizen, seeking and acting on accurate advice, is at a disadvantage. His proper disclosure, filing, and payment of tax when appropriate is a lonely per- formance in an area where "everybody" is certainly not doing that. An enforcement system would do at least two things, and possibly `a third. First, It would raise the awareness of the problem. Second, it would result in a more evenhanded treatment of all taxpayers. Finally, it might raise revenue, though the curious nature of the acquisition of joint holdings leads to skep- ticism on this point. Buildings of joint property are generally of an "Install- ment" type. Stocks are bought a few shares at a time. Homes are acquired with mortgages paid off over years. it seems a fair statement to suggest that the gift tax marital deduction and annual exclusion would cover a great many situations and thus little revenue would be raised by better enforcement mecha- nisms. Inequity.-Leaving aside every other objection t~ the joint property prob- lem than inequity would still leave a completely persuasive case. The two major statutory revisionS in the area that have occurred sought t~ deal principally with the inequity problem. Though they helped, they were still to~ little to ac- complish the appropriate result. The reference, of course, is to the Revenue Act of 1948 and the addition of Section 2~15 by the 19~i4 Code. The first sought to create equality between citizens of community property states and common law prbperty states. The second sought to dc-fuse the widespread noncompli- ance in husband-wife acquisitions of jointly-held realty. It is submitted that neither of these revisions went far enough. Inequity goes beyond the statutory scheme. Uneven administration and en- forcement are additional~ sources of Inequity. How many inequitable results have occurred because "tracing" could not be achieved or achieved with any de- gree of reliability? How equitable is it to accept the proper and timely retur~is PAGENO="0783" 769 and payments of a careful and sophisticated taxpayer while taking no steps to identify and require compliance from ill-advised taxpa~ers ~bo are doing ~What "everybody" does? Of inequity at the level of the statutory scheme, the major chore is to com- plete what was left unfinished In 1948-the matter of Interspousal transfei~s. An example helps: John and Mary Community Property versus John and Mary Common Law Property, John and Mary Community Property spend a lifetime of effort and accumula~ tion. John always worked and Mary never was gainfully employed. They own all of their property as community property, ftnd at John's death his one-half of the community yields a taxable total it his estate of $100,000 on which a federal tax of $4,800 ispaid. At Mary's latçr death, her half of the community, likewise worth $100,000, is taxed and another $4,800 Is paid. John left his half of community in a form which was not taxable at Mary's later death, If the sequence of deaths is reversed, the result is the same. John and Mary Common Law Property are a very similar couple. Equally diligent, equally loving. They do what "everyone" does In a common law state. They acquire all their assets In joint tenaucy. They view It as a substitute for a will, and John dies. So far, so good. He has an estate composed of the full $200,000 but be has a surviving spouse and the joint property qualifies for the marital deduction. So, his tax Is $4,800 on his net estate of $100~000. Then Mary Common Law Property does. Her estate is $195,200 (the $200,000 l~ss the estate tax). Her tax is $80,187. The total taxes in both estates Is $84,937. Mr. and Mrs, Common Law Property dies. Her estate is $195,200 (the $200,000 lees `the estate taxes than Mr. and Mrs. Community Property. If the sequence of deaths is reversed, the difference Is also substantial. John's estate Is $200,000 and there Is no marital deduction. His federal estate tax is $81,500 compared to the $9,600 paid by his frlefl4s a few miles away in the communjty property jtirisdlction, a difference of $21,900. * What about honest and sophisticated John Common Law Property who wants `to divide his estate with his wife to get a better result? When he finds out the bad news, he decides to make a completed gift to Mary of $100,000 to .equali~e their estate. If he lives three years, then it Is `true that he and his Mary have one slight advantage over the Community Property John and Mary. The first to die can use a marital deduction, so that the first estate will be `$50,000 and will owe no federal estate tax. The survivor will own his or her $100,000 plus the $50,000 received `as a mayltal deduction from the first decedent, `and will owe a federal estate tax of $17,500. `This is $7,900 greater than the Community Properties paid In both estates, but it is accomplished without any loss for estate taxes at the first death as opposed to the $4,800 which `the Community ~Propert1es paid. Nonuse of the marital deduction in the first estate ~y the Common Law Properties would yield an identical estate tax result, though the Community Properties would have an additional benefit that could be Important-the Income tax basis of the surviyor's half of the community would b~ "stepped up" while the survivor in the common law property state would have no adjustment in basIs~ A Possible Resolution The previouc recitals are intended to catalog something of a horror story. It is a story with at least these chapters: Great complexity Low public awareness Widespread misinformation Widespread noncompliance Difficult administration and enforcement Suspected low revenue production Inequities among citizens of the same and ~f different st~ites Insufficient past measures of correction If a case is made by these conditions, what theü Is a remedy?' As a bedrock 2 It has been suggested that an extension of Sectiors 2515 to all inferspousal 5~int ten- ancies would cure or ameliorate the situatiob. It is submitted that this wotild be una~rail~ ing to solve the mator problem. Unless "tracing" at death was also eliminated, all Of the present uncertainties and uneven treatment would fersist, and they are a substantial part of the problem. In addition, a lifetime giving program to a spouse is often desired. Section 2515 is counter-productive to this because it~ effect is to rule out a gift `at the time of creation of a joint tenancy unless an election is made. The election process is little known, and therefore frequently overlooked. When the facts become known, the property may have appreciated greatly and a completed gift by severing the joint tenancy may be very costly. PAGENO="0784" 770 beginning, it is submitted that a tax system which can integrate rather painlessly with what "everybody" does without unduly damaging the revenue is a desirable tax system. And what "ev~ybody" (or a very large majority) tends to do In the marital property ownership area Is to arrange that ownership in ,a way that suits the particular purposes of the marriage while acting as `if there were no federal gift taxes as far as husband and wife transactions' are concerned. That translates to an existing pattern of interspousal transfers being made with a widespread and flagrant disregard of the existing federal gift tax laws. Since no great impetus to correct this appears to be forthcoming, It would appear to be a logical extension of the statutory efforts of 1948 and 11154 to provide that no~ arrangemejat of property by and between spouses during life in any form of title in their names whatsoever will be `a tasable event for purposes of the federa' gift tas~, In other words, a provision for totally free lifetime ln'terspousal transfers of property for federal gift tax purposes. Admittedly this is a broad proposal to deal with the joint Interest problem. However, the joint interest form of title holding is really just symptomatic of the whole area., although it symptomatizes the worse part of the disease.8 To cure joint tenancy problems only while leaving other interspousal transfers as is would again create mass confusion. The suggestion Is simply to "give-up" of a major area of misunderstanding, confusion and noiwompllance. In `the opinion of the writer it would go far toward making the territory under exploration a civilized and settled one. Later portions of this paper detaIl proposed and existing mod- erating elements to curtail reckless use of the privilege, and they are' an integral part of the proposal. What Estate Tas Change'~ Are Desirable? What of the estate tax? Profound questions can he and have been `raised by others concerning the estate taxation of "marital property" and interspousal transfe,rs~ The purpose here is not to address such broader questions, `but to examine only the widespread use of joint property by married couples. As an extension of that concern, two estate tax problems are thportant. One Is the estate taxation `of jointly~beld nroperty. The second Is the contemplation of death problem inherent in the free lifetime Interspousal transfers proposed as a solution to the former. Estate Theatlon of Jointly-Held PropE~irty.-.There appear to he two principal problenis with the current estate taxation of joint Interests. The first is that notwithstanding the occurrence of a taxable event on `the accpilsition of a jointly- held asset during life, there is a re-taxation for estate tax purposes, with a goncomitant credit where applicable, which is unavoidable if the property remains li~ a joint tenancy, but which can be easily avoided by a conversion of the form çf property holding tO a tenancy In common or outright ownership of discrete jtems of property. John may have paid $200,000 for a Jointly-held securities portfolio, and he may have' paid the required gift taxes on this. When John dies. however, the entire portfolio Is now in his taxable estate, with a credit for those gift taxes. He encounters two taxes, and derives relatively little benefit from dutifully complying with the first gift tax. Had he severed the joint tenancy, half the assets would be out of his estate, no "tracing" would be required, and the administration would be measurably tidier. There are other areas where payment of a gift tax may be Inconclusive on estate taxation. Sections 2035, 2036, and 2087 produce similar results. ~et the Imnact of these Sections falls most heavily on sophisticated taxpayers. Pre- sumably they are taxpayers who have created trusts, made substantial inter vivos gifts, and generally engaged in complex and advanced estate planning. The joint property problem has an Impact on a far less sophisticated John an~ Mary who were probably originally drawn into the ambit of the joint property trap as a simule extension of a concept ~f marital unity during life rather than as an esoteric exercise in disinheriting the federal government. The second problem Is that of tsacing. Tracing Is an extremely inexact activity, and the necessity of it to achieve a reasonable result is a heavy burden for' tnxpayers who never knew the problem was coming. There are undoubtedly many situations where inequities arise because of the absence of' records or the Tl~ere is, for examnie, the nightmarish area of untitled personal property such as household furnlshin~ts. Some forms of tangible personal property, such as art and coin and stamp collections, can be repositories of considerable value. Few worried couples consider their tangible personalty as anything other than "ours," though the laws of most states wQuld not accept a conceptualized viçw as establishing joint awnershib without more. PAGENO="0785" 771 absence of a surviving spouse in full p~sesslon of his or her faculties, Includlng~ an accurate memory. Both of these proble~is are susceptible of a reasonably simple solution. The first problem would be solved by the suggested e~iminatlon of gift taxation on Interspousal arrangements of property during life, If there bad never been a gift tax paid or payable, the p~sslbi'lIty of a secofld tá~P with a credit would not exist. Conc~rnlng ~l~e second problem, which is the lnexactitu4e and Inequity of tracing, It is submittedthat a rule of certainty, easily applied, administered, a~d enforced, w~flld be an answer.' The estate of the first member of a married couple to die ownh~g jointly-held'property would Include one-half of the fair market value of that property. No tracing, would be required or allowed. Whili~ It could be argued that the tenancy by the entireties situation should be treated differently, with the use of the actuarial value, as distinguished from a simple fraction of' one~half, It is submitted that it is desirable to conic reasonably close to a national standard which can be applied evenly in every state, and that the half and half treatment does this with no significant loes of revenue. Interspo~aI Tran,sfers in Uon~tempIaUo~ of Death.-Assuming a continuation of a separate gift and estate tax system, It would follow that Section 2035 would be retained In some form. While it is beyond the scope of these suggestions, it is nonetheless suggested that an objective system would be preferably to today's "rebuttable presumpti~n." Proving the motive which a deceased person bad for a gift is one n~ore admlnistrathre interface that turns out to be highly difficult. A suitable coitipromise might be a shortening of the prescribed period to 24 months, accompanied by absolute inclusion, regardless of' motive, or' tranafers within the period, and absolute exclusion of transfers beyond the period. Regardless of the actual sOlution on contemplation of death overall, `how should the suggested free interspousal lifetime transfer problem be handled? Let us first look at a situation well beyond the contemplation situation, and also not involving joint property. John decides that his' estate planning will best be served by constituting Mary the owner of half of his assets. He transfers into her name alone some $100,000 of his $200,000 estate, retaining the other $100,000. He dies and his estate Is $100,000 `but he uses a marital deduction of half of this, leaving a nontaxable estate. At Mary's later death, she has her own $100,000 plus the marital deduction assets of $50,000, resulting In a taxable estate of $150,000 on which a federal estate tax of $17,500 is paid. John could, had he wished, have opted for no use of the marital deduct1on~ leaving Mary an interest In a "nonuuallfied trust" and he `would have paid a $4,800 federal. estate tax, as would Mary at her later death, for total taxes of $9,600, or a savIng through no use of' the marital deduction of $7,900~ Presumably under today's statutory pattern4 John would have transferred the $100,000 to Mary with some gift tax cost ($~53), or over a period of time with none. In neither case would the gift tax re~exnie In thi~ particular case be significant. Now assume that the suggested free interspousal lifetime tra~n~fer provisions are the law, and that the transfer to Mary is beyond the three-year contemplatIon period. The only difference isthat the gift tax cost of ~953 was never paid. Other facts remain constant, `and John still has a decision to make as to how much, if any~, of the marital deduction he will n~e. The rate structure has a significant Interplay' here, but it is demonstrable that the njtftn,ate ~revenue, assuming no significant ehang~ in the vaine of" the `assets iti the survivor's hands, is not badly affected, (~hart I demonstrates this. The, chart shows what experienced estate planners know-'-4n larger estates it is worthwhile to save taxes at the first death when estates are roughly equal because total taxes changes comparatively little but the use of the tax money lost to the family during the lifetime of thesurvivor can be aj~reelable. Compare the tax burden at the death of the first decedent by using or opting against the marital deduction, demonstrated in chart ii. Column 4 shows `the tax dollars the family will have available during the life- time of the survivor, even though Chart I showed that the total tax bill in the last two situations will be slightly more, while that in the first will result in a definite tax saving. This treatment would be approprjate whether or not there were free interspousal transfers at death. It would be a rule of `certaInty `to simplify quc~tions of the size of the gross estate of the d'ccedeat, If there were free Interspousal transfers at death, it would ~1mply be transferred under such procedure. If riot, it Would enter intø couiputatioh of the inaritsi deduction as joint property now does, bCt there would be a certainty of inolusion of only one-half of the asset in the gross estate, unlike the present "tracing" situation, 68-872--76-50 PAGENO="0786" 772 CHART I There is thus a revenue impact with smaller estates (total assets in both estates of $400,000 or less). Yet today's planning possibilities do nothing to pro- hibit this type of result-they simply extract a gift tax if an equalizing transfer of a substantial amount is made. Now take the same transaction into the contemplation period. It would appear proper to assume that if a substantial donative transfer was to be made at a point in life when a contemplation of death situation might arise that it would be done with sophisticated advice. That advice would very typically be accom- panied by the pr~páration of a dispositive instrument which would use a full foi~mula-quantifled marital deduction~ ilence, even if a contemplation case was lost by the taxpayer under the current law, the overall disposition of the estate after the transfer was restored will still result in substantial tax saving at the first death, although less than would be the case if the estates had been success~ fully divided beyond the proscribed period. The situation would come close to Columns 5 and 6 in Chart I. Again, under ex4~ting law a gift tax would probably have been paid on a massive transfer within the contemplation period, but would in turn function as a credit against the estate tax so that it would have contrib- uted littje to the revenue. These examples are intended to show that under existing situations the reve- nue effect in both estates is materially different only. in smaller estates where the impact of the exemption and the low rate structure is available as a plan- ning tool. Yet, the opportunity for those savings is available under legislation first passed in t948, and not in any sense to the proposal here described. Like- wise, some gift tax would obviously be `lost but the quantum of gift `tax that would be payable `under any circumstances on estates with `~a total value for both spouses of $200,000 would necessarily be small. A total gift of $206,000 to a spouse at One time, assuming a full available lifetime exemption, would amount to a net taxa'ble gift of only $67,000 and a gift tax of $8,595. An "equalizing gift" of $100,000 would amount to a net taxable gift of $17,000 and a gift tax of $953. Still, it takes little'imagination to conceive of circumstances In which very large transfers might be engineered from a death bed with a~ consequent heavy loss of early realization of revenue. To switch the tax timing on $3,600,000 from a terminally-ill spouse to a healthy surviving spouse with no other assets would postpone realization of $1,328,000 in federal estate tax. The figure for $6,100,001) of assets is $2,643,400 and that for $10,100,000 is $5,036,200. To postpone realiza- tion of amounts of revenue in this magnitude `by admitted death-bed transfers is certainly beyond the purview of the suggestions being made here. Federal estate taxes at Federal estate second death taxes at each Federal estate on survivor's death with no taxes at first own estate use of marital Difference death with full plus marital deduction in Assume equal net estates use of marital deduction first dece- Two times for John and Mary of deduction assets Total dent's death column 5 between columns 4 and 6 (1) (2) (3) (4) (5) (6) (7) $200,000 (total $400,000). $4,300 $59, 100 $54, 310 $31, 501 $63, 000 $300,000(total $600,000). 11,500 102,100 119,600 59,100 118,210 $500,000 (total $1,Q00,000) 45, 300 191, 800 237, 100 116, 500 233 000 +$8, 700 -1,400 -4, 100 CHART II Federal estate Federal estate taxes if full taxes if no marital deduction martial deduction Estate of first decedent used used Difference (1) (2) (2) (4) $2ô0 000 $4 800 $31 500 300,000 17,500 59,100 500,010 - 45,300 116,500 $26 700 41,600 71,200 PAGENO="0787" 773 What then would be a sensible form of limitation on an otherwise exempt transfer to a surviving sp~use durln.g the contemplation period? The principal objective being urged here is to permit all U.S. estate taxpayers to "split" their taxable estates with their surviving spouses during their' lives without gift tax consequences and w1th~ effectiveness for estate tax purposes. To await death to achieve this under the pattern set in 1948 means that it will not be achieved If the less affluent spouse pi~ecedes the more affluent spouse In death. In such cases lifetime transfers `to achieve the split without risking the less reliable sequence- of-deaths is the answer4 This has been an inhibited ansWer in common law prop- ~erty jurisdictions, however, because of the way in which the gift tax marital deduction operates. A "splitting" of a $500,000 estate at death, for example, re- sults in a $250,000 tax-free transfer to a surviving spouse and full freedom re- garding imposition of conditions on the "notiqualified" portion. A lifetime transfer to make the identical division at one time results in a tax-free transfer of only $125,000. That results from a transfer to the spouse of $250,000 of which only $125,000 is deductible as a marital deduction. If the suggeeted free lifetime trans- fer was enacted, this difference would disappear. The equitable answer on the con- teinpiation issue appears to be the structuring of the "split" but no more into a revised Section 2035. This would call for a gross-up in tl~e estate of a decedent of all transfers to a spouse' within the contemplation periOd followed by includi- bility in the decedent's estate of all assets in excess of half-~essentially the same thing that happens in applying Section 2035 tO qualified transfers to a surviving spouse under the Revenue Act of 1~P48. As an example, assume John Common Law Property had an estate of $400,000 and he became terminally ill with cancer. lie decides to' eliminate any estate and transfers the entire $400,000 to Mary. He dies within the contemplatioh period. His estate is grossed-up at $4®,00O~ One-half of this would be exempt because It was to a surviving spouse so a tax is imposed on all assets beyond the "split" transferred within the contemplation period. Essentially, the current law would be retained to apply to lifetime interspousal transfers within the contemplation period, though far lCss emphasis ~hould be placed on the precise mechanism of transfer to qualify for the marital deduction, Such a process should put a brake on reckless 4eatb-bed~ transfers of entire estates, while still preserving a reason- able opportunity for all American couples to achieve the "split" that is at the heart of the very advantageous community property laws, and is in accordance with the perceived situation which most couples have of property acquired dur- ing marriage. Another brake on massive death~bed transfers In large estates is a reference to simple and Intelligent estate taxation mathematics. It is readily a~parent to the majority of estate planners that the use of a "100% marital deduction" or completely free lifetime interspousal transfer `of all property to a surviving spouse would be appropriate only In small esthtes. So long as there is a gradu- ated tax bracket, total taxes on both estates `will almost always be higher if the entire quantum of the property of bdth spouses is taxed at only `one time rather than at two times. Simplistically viewed, the estate tax exemption of the first deceased's spouse Is lost if all of the property is taxed at the deatl~ of the sur- i~ivor, Perhaps then the overall situation would best be served by making it pos- sible to use a free lifetime interspousal transfer or a "100% marital deduction" while leaving to appropriate professional application of planning concepts the way in which this particular privilege would be used. As. to the form o'f a qualified inter5poiisal transfer, many suggested statutory provisions have been developed over the last 15 years for free interspousal trans- fers. The proposals have discussed quite competently the matter of the kind of interest which ought to satisfy a "100% marital deduction" provision in the law and reference to these is sufficient. ConcZus'ion `This submi8slofl is buttressed on the proposition that the best tax law is a law which tends to conform with classic and typical patterns of action on `the part of taxpayers rather than one which either shapes those aetloim or is seriously at odds with 1~hem. Since those classic and typical actions on the part of married couples acquiring property so frequently results in an owbez-sblp o'f property "together," the gift and estate taxing system ought properly to recognize this and deal with It realistically and wfthotit penalties. `Certainly any taxing system that results in a substantial majority of the citizenry being noneompliants can- not be an acceptable one. The suggestions made here are not intended to have PAGENO="0788" 774 any material revenue reducing effect, hut to eliminate confusion and noncompli- ance in an area of very widespread common experience. The ChAIRMAN For our next panel we have Joseph Hubenak, chair- man of the House Agricultural Committee of the Texas Legislature, for the National Conference of State Legislatures; Raymond Roister of Minneapolis; William Brownlie of Boston; a~id Donald 0. Smith, Boston. A PANEL CONSISTING OP TOSEPH HUBBNA1~, NATIONAL CONPER. ENCE OP STATE LEGISLATURES, AND CHAIRMAN, ROUSE AGRI- CULTURE COMMITTEE, TEXAS LEGISLATURE; RAYMOND EtEISTER, ESQ, MINNEAPOLIS, MINN, WILLIAM D BROWNLIE, BOSTON, MASS.; AND DONALD 0. SMITH, ESQ., BOSTON, MASS. STATEMENT OP JOSEPH HUBENA~ The ChAIRMAN. Mr. Hubenak, we welcome you as well as the other panel members to the committee. We will be happy to hear you. With- out objection your full statement will appear in the record and you may proceed to summarize. Mr. HUBENAK. Thank you, Mr. Chairman. Members of the Ways and Means Committee, Congressman Burleson. Good Texas Con- gressmen. I am Joe Hubenak, and I serve as the chairman of the Agriculture ~nd Livestock Committee of the Texas House of Representatives. I am appearing before you today on behalf of the National Conference of State Legislatures, the official organization representing the Na- tion's 7,600 State legislators and their staff. NCSL has long supported revision of the Federal estate tax laws and has recommended that the present exemption level, of $60,000 be increased substantially. However, after further study, we extended our position at a meeting last week to include that: 1. The present $60,000 exemption be increased to $200,000 for all estates; 2. The marital deduction for all estates be increased to 50 percent of the adjusted gross estate, plus $100,000; and 3. Farm property be assessed at its value for current agricultural use, and not `at its market value. While raising the exemption level should have the highest priority when Congress revises the law, the other two provisions are essential, for reinforcing the positive effect on small businesses and farms. Changes in this law will have major ramifications, both for the finan~ cial stability of those who inherit small estates and, more importantly, for the fabric of American agriculture itself. Statistics show that the small farm is disappearing at an alarming rate. Some estimates indicate that the United States will lose between 200,000 and 400,000 farm's over the next 20 years. Even the U.S. De- partment of Agriculture projects that America will have 1 million fewer farm units by the turn of the century. The average age of a farmowner today is 51, which indicates that the young generation `cannot remain on the farm for one reason or the other. PAGENO="0789" 775 While we are talking ftbøut small farming uni1~, ~ I would like t~ mention that in the last 20 years, the success that the Soviet Union arid other foreign countries have had in increasing their: agricultural out~ put has been through entithrtg the small farmer to a few acres along side of the socialized farming operation. One study conducted by the Department of Agriculture indicates that the small farm, managed and operated by One to thres people, is the most efficient unit f~r agricultural p~roduction. This 168 stud~r points out that efficiency reaches a plateau with the small unit and remains constant through the iarge~ize range. Agriculture is just not subject to the same opportunities fo~ economies of scale that indus- try is. Losing these units, then, will have serious repercussions for the productive capacity of American agriculture At a time when the world is demanding more food from the American farmer and when agricultur~al exports are maintaining a healthy balance of trade for this country, loss of these units cannot be tolerated. The pressures of urban development are also taking their toil on the availability of prime agricultural land. Such urban growth consumes about 22 million acres of farmland each year-i-and 20 percent of all farms in this country are already within metropolitan areas. It is on the rural urban fringe, though, where the small farm suffers its greatest demise. The pressures of development force up land values in this margin. Land then takes on a speculative value, an artificially high amount. To aggravate the problem, an heir to farm property in this fringe area discovers that the high property value causes Ins estate taxes to be exorbitant. Unfortunately; a farm~s productive capacity does not increase when its market value increases Therefore, to afford the payments, an heir must sell the land, even if he desires to keep it in agricultural uSe. The unfortunate result is that more acres of produc~ tive agricultural land are surrendered. I might speakfrom my personal experience. We moved to Brazoria County on the gulf coast between Houston and Freeport. In 1948 we bought 150 acres at $55 an acre Today that land is selling for $4,200 to $5,500 an acre, and it produces no more corn, maize, or cotton than it did in 1948. But the taxes have skyrocketed. In rural areas this problem is also arising as the pressures for devel- opment, particularly from second home and other recreational comrn mumtiee, are increasing Farm property is especially attractive to a developer because it is nearly fiat, is cleared of trees and shrubs, and generally has good drainage. Another problem in rural areas is the growing infirience of agri- business and corporate landholders which further erodes the land available to the small farmer. More and more of America's large cor- .porations are becoming agricultural landowners. Nationally, eight oil companies own almost 65 million acres.-13 times the size of New Jersey Aud corporations such as Coca Cola Standard Oil of Cali- fornia, arid l~CA are invulved in agricultural production. State legislatures across the country are alarmed about the disap pearance of the family farm and the accompanying decrease in the availability of prime agricultural land. Many legislatures are now attempting to rectify these problems For example4 several States are currently proposing changes hr their own State estate tax laws. Most PAGENO="0790" 776 are increasing their exemption levels, such as Wyoming, which' has raised its exemption to $60,000 from $10,000. Other States, such as~ Minnesota and South Dakota, are attempting to `equalize deductions' for widows and widowers. Wisconsin is also examining the possibility of deferring tax payments on inherited property. And the Minnesota Legislature has provided for an alternative tax valuation method. If the estate `passing to the surviving spouse is less than $500,000, and if the tax computed on 50 percent of the estate, without using exemp- tions, is less than the tax computed with normal exemptions on the entire estate, then the lesser tax can be paid. Several other States, including Vermont and Massachusetts, have developed State food policies that recommend, among other changes, estate tax benefits for farms which are willed to succeeding generations and remain in active farm production for a certain time period. Ver- mont is also considering the feasibility of exempting the first $10,000 of net business income, including that of a farm, from taxation. The Massachusetts Legislature is considering a bill. to value farmland at its current use for State estate tax purposes. Other `State legislative actions to preserve the family farm includet regulation of corporate farming. Nine States-Iowa, Kansas, Minne- sota, Missouri, Nebraska, North Dakota, Oklahoma South Dakota, and Wisconsin-have enacted laws in this area. Kansas was the first to do so in 1931, and North Dakota followed shortly thereafter. `Kansas law specifies that if a corporation is allowed to farm a specific list of' crops, it must have 10 or fewer stockholders, the incorporators must be State residents, `stockholders cannot own stock in any other corpora- tion, and the corporation cannot own or supervise more than 5,000 acres. North Dakota prohibits virtually all corporations from farming. In addition, the majority of States have laws attempting to preserve prime agricultural land. Most try to accomplish this by alleviating t'h~ property tax burden. Three general approaches have been used : prefer- ential assessment, which allows land to be valued at its current use, not at its market value; deferred taxation, which also allows land to bet assessed at its current use value, but which provides that if farmland is used for development, unpaid taxes on the' market value are recap-' tured; and restrictive agreements, which allow State and local govern- ment's to~negotiate `with a landowner to restrict development in ex- change for a tax preference.. At least nine States have preferential assessment laws, although requirements for participation vary with each `State. At least 17 States have deferred taxation laws. And still other States are considering' development rights and easements. The Californi.a Legislature is also considering a bill to establish an Agricultural Resources Council to~ have final authority over the State's prime agricultural lands. I might remind you also that today, California ranks first in agri~ cultural income. Still other legislatures' are experimenting with programs to assist the young farmer. In the Minnesota House of Representatives, for- ex~ample, there is a bill to aid young farmers in obtaining credit to acquire farm real estate. The legislature has recognized the need to- encourage young farmers to remain in agriculture; however, Federal estate tax laws force them to leave. State actions to preserve the family farm and its accompanying agri- cultural land will never result iii substantial success, however, while PAGENO="0791" 777 the federal estate tax imposes such an exorbitant burden on the small farmer and heim to farm prOperty. Therefore, NCSL recommends that, first of all, the exemption level be increased to $200,000 for all estates. Studies ~how that with the current rate of inflation, an exemption of at least $190,000 would be necessary to equal the 1942 purchasing power of the $60,000 exemption. Examples .abound of how farmland purchasecl.in 1942 at.$50 per acre is now worth $1,000 or more per acre, An antiquated exemption of $00,000 is not nearly substantial enough to ease the tax burden on an heir. Second, the marital deduction for all estates should be increased from the present 50 percent of the adjusted gross income to $100,000 plus the 50 percent rate. Changes in this provision are necessary to recognize the partnership which exists between husband and wife and to alleviate the discrimination against women which currently exists in the estate tax laws. And third, NCSL recommends that farmland should be as~essed at its value for current agricultural use and not at its market value. By including this provision, an heir to farm property located in areas pressured by urban development will not be forced to sell land that he wishes to keep in production. NCSL also supports a provision stipulating that land assessed at its current use value be kept in that use for at least 5 years prior., to and 5 years following the owner's death. Then, if the land. is sold or converted to development, the market value assessment would be invoked. This current use provision could also be extended to include woodlands and scenic. open space, as well as agricultural land. All of the provisions which NCSL recommends are incinded in a bill sponsored by Representative Omar Burleson, Democrat, 0 Texas, a ranking member of the Ways and Means Committee. In summary, a combined State and Federal effort is needed to main~ tam the viability of the family farm and to insur~ that prime agricul- tural land is. preserved for the food production so essential to the' `American consumer and our foreign customers. The States have real- ized their role in rectifying the problem, but without these re~om- mended changes in the Federal estate tax laws, State actions will be greatly overwhelmed. Thank you, Mr. Chairman, for this opportunity to recommend legislation to ease the'burden of Federal estate taxes on those who in- herit small businesses and farms. Mr. BURLE50N [presiding]. We appreciate your being here. Belat- edly I welcome you warmly to this committee. The next witness is Mr. Reister. We will be pleased to hear you, sir. STATEM]~NT O~ RAYMOND REIST~lt, ]~SQ. Mr. REIsni~R. Thank iou, ,Mr. Chairman. I would request permission to submit later a written statement of the views which I will summarize now. Mr. BURLE~ON, Your full statement will be included in the record. Mr. REIsm1~. My ~name is Raymond A. Reister. I am a practicing lawyer from Minneapoiis, Minn. I am a parther with the firm of Dorsey, Windhorst, Hannaford, Whitney & Halladay, specializing in. PAGENO="0792" 778 the area of probate and trust law. At present I am a visiting scholar &t the Brookings Institution in Washington, D.C., where I am doing research on `the problems relating to the credit against Federal estate taxes for State death taxes paid. I speak as an individual and only for `myself. As you are aware, un'der section 2011 of the current Internal Rev~ ernie Code a credit is given against"the Federal estate tax liability for the payment of State death taxes actually paid in `an amoñnt not to ex- ceed 80 percent of the basic egta,te tax under the 1926 Federal estate j~ax law. This credit does not apply to the so-called additional estate tax which was adopted in 1932, and subsequent amendments and additions to that tax. As a result of this limited application, the credit has much greater advantage `to larger estates and therefore to the richer and larger States. Over the years there have been repeated recommendations for changes in the law with regard to this credit. `The principal such rec- ommenda'tion was"the 1961 Report of the Advisory `Commission on In- tergovernmental Relationship which recommended, among other ~things, the adoption of a two-bracket credit. For example, it was suggested that the first bracl~et credit be 80 percent of the `tax liability on the first $150,000 of estate assets and the second bracket be a 20-percent credit against the tax liability on the balance of the estate assets. Also, under the current law of the vari- ous States~ there is a great difference in the kind and the terms of the State death taxes. The most common are the inheritance taxes. Soitie States have estate taxes like the Federal tax, and most have `a so-called `pickup tax which is designed to insure that the State tax be at least sufficient to qualify for the maximum amount credit under the Federal law. Also, I would like to note for the committee the fact relatively little revenue is produced by the Sta'te and Federal death taxes. In 1973, for example, the Federal estate tax after credits produced $4,152 million. `The total amount of estate tax credits in that year amounted to just under $500 million. The Federal estate tax produces about 2 percent ~ the revenue of the Federal Government. So far as the States are concerned the State dea'th taxes amount to approximately $1,431 million, and after subtracting the credit, net State death taxes total approximately $954 million. State death taxes also produce about 2.1 percent of the revenue received by the `States. As a result of my studies, `may I suggest that `as part of the reform of Federal estate and gift `t'ax laws, Congress consider Fed~ral preemp- `t~on in the area of death taxes in order to produce uniformity and simplicity. This is not a new idea. It was one which has been repeated ~on numerous occasions, and originated in the days of Theodore Roose- velt whe'n he first suggested the concept of a Federal estate tax. Specifically my recommendations are, that the States repeal all of `their death taxes in whatever form they might have. In return the States which repeal their death taxes would `be entitled to' a credit similar to the one now in effect except that it would be based o'n a for- inula somewhat as follows: First, there would be an 80-percent credit on the first $150,000 of the taxable estate much as that recommended in the 1961 study by the Advisory Commission on Intergovernment PAGENO="0793" 779 E~ii~hips.This wouid.insure gi~eater stthiilty of tax ce1ie~tions and re4~,ogrnze the local nature of small estates Second, there could be ~ui 80 percent credit of the pro rata share of the tax attributable to the net value of the real estate m eath State. The portáon of the credit would be given in recogthtion of the reJa~ tionship of each State to the real estate located in it and therefore its entitlement to a larger amount of the credit from the estate taxes paid on that property. Third, each participating State would be entitled to a share of a pool equal to 20 percent of the remaining Federal ta~ to be a11o~ated in accordance with a formula consistent with then current theories of revenue sharing For example, population, the percentage of collec tions from the various States or other~criteria' such as those which were considered at the time revenue sharing was initially adopted in 1972. A precedent for the use of a credit to obtain uniformity among the States can be found an the credit given by the Federal Government for payments as part of unemployment compensation programs The State where the executor or administrator of an. estate was initially appointed or if there is none, where the Federal estate ta~ return was filed In case of dispute between States as to residence of the decedent, the taxpayer will be entitled to receive the first bracket credit for that estate He would not be involved directly but the States themselves could negotiate or arbitrate by a panel `as to the proper State of residence This would avoid t~he present double domicile problems which are very difficult so far as estate planning is concerned, and it would also minimize `~tax haven" possibilities. With regard to the revenue effect of the plan, at the present time a substantial portion of current State death taxes are collected from the small estates, that is the estates under the $60,000 Federal exomptrnn or where no Federal tax is collected ror the larger estates there are both overlapping Federal and State returns required on overlapping taxes paid. Again the vast majority of these estates are the smaller estates. .The rates of State death taxes vary greatly amdng the States and therefore if Congress were to provide an additional credit to the States the amount ofthat credit would not only he~ve to be sufficiently high to cover the current State collection (approximately $1 billion net of the present credit) but also for uniformity on additional amounts of credit States which at the present time impose to them State death taxes at lower rates. Note that this latter is not a revenue loss to the combined Federal and State governments, but a shift from the Federal Govern~ ment to the States in accordance with a plan consistent with the pur pose of revenue sharing. Variation in the amount which i~ to be shifted can be easily made from time to time by changing the percentages for the State and Fed eral shares and the size of the brackets Also revenue loss can be minimized by lowering the exemption and increasing rates in the lower brackets to compensate the replaced State taxes Finally, several advantages could also be made with respect to the administration of the tax. First the Internal Revenue Service would ha~ve the sole. authQrity for the administration of the death tax program throughout the country This would produce uniformity, avoid the difficulties of liens and prohibitions against transfer which are now prevalent in most States, and also remove from the taxing PAGENO="0794" 78Q and administratjon, o~f State.4eath taxes the presence of Stat~proba~te ~courts. Such a policy would also remove inconsistencies between Federal and State policy. For instance, one of the major issues before :~OÜ is the question of reforming the delayed payments provisions now in the code. Few State~ have such dthrral prpgrams for their State taxes. Therefore if Congress does want to f'wor delayed payments the fact that the States do not permit this will be inconsistent ~nd contrary to Fed*era~l policy. There have also been repeated requests to you that the amount of the exemption be increased, but if the exemption is increased for Fed- eral purposes there is nothing now to prevent the States from absorb- ing the slack by i*iereasing their State death taxes Again Federal preemptions will insure that there will be consistency in Federal pro- grams with regard to estatetaxes. In summary, I believe that such a program can avoid the problems of double domicile and death tax havens. I believe it will eliminate the restrictions, on. transfers during, probate and avoid the problems caused by liens for death taxes. It will simplify greatly probate procedures, and eliminate probate courts from the administration of death taxes, and will thereby be a major probate reform. It, would give, uniformity to death taxes `throçughout the country, It would also rationaliz~ the revenue-sharing effect of the cprrent, estate death tax credit,, and greatly reduce the burden of preparing tax returns and paying taxes on very large numbers of small estates which in many cases are duplicates. Thank you very much. Mr. BURLESON. Thank you~ Mr. fleister. We will now hear from you, Mr. Brownlie. You may summarize, and your full statement will be included in the record. STATEMENT OP WILLIAM D. BROWNLIL Mr. BROWNLIE. Thank you, Mr. Chairman. Mr. Chairman, members of the' committee, it is a pleasure and an hqnor for me to be here today. My testimony is specifically directed towards the Federal estate tax inequalities that presently exist and affect Keogh, H R 10, and mdivid ual retirement account, IRA, plans. I am William P. Brownlie, a full-time Boston life insurance sales- man specializing in self-employed retirement `plans. I am appearing today as a private citizen. I am not representing any ~peeifle clients nor do 1 represent any association or organizations. However, during my business career, I have been responsible for the *cr~tion and design of over 1,000 self-employed retirement plans- most of them in the Keogl~, H.R. 10, area. I am here today to inform the committee that millio~is of Americans who are investing their hard earned dollars ihto either Keogh or IRA plans are not receiving the same tax considerations as those covered `under corporate retirement plans-particularly in the area of the Fed- eral estate tax exemption. The beneficial tax provisions of corporate ~etirement plans have served both the country and its citizens well over a period of years. It goes without saying that corporate retirement plan assets amount to PAGENO="0795" 781 billions of dollars. and are ~ const~nt source o~ revenu~fo~nv~stm~nt in theeconomy of our country. Tjnfortunately, these beneficial longstanding ta.x~provisions available for corporate retirem~ent plans aren't available for individuals utiliz- ing either Keogh, ER. 10~ or IRA plans. Specifically, section 2039 of the Internal Revenue Code states that corporate retirement plan assets are not subject to the Federal estate tax when a participant dies, if such plan assete are payable to a named beneficiary, meaning spous~, ôhildren, paretit~s, ot personal trust. * The Federal estate tax e~emption which is available for beneficiaries of corporate retirethent plan participants is `not allowed for bene- ficiaries of Keogh an4 IRA plan participants. This is unfair and discriminatory, and I do not believe it was and is the intent of Congress to have it this way~ A simple amendm~nt to section 2039 of the Internal Revenue Code would solve this severe inequity ilTithediately. Do you realize that if a 40-year-old self-employed individual iflvests $7,500 each and every year in a Keogh plan for 25 years, and earns 8 percent compounded interest, a retirement fund of $~9~i58 will be created. Ho~e~ver, if' this individual should die at age 65, $592,1~8 will be subject to the Federal estate tax under curreht law. Conversely, not one penny of $592,158 would be subject th the Federal estate tax if the same results were achieved as part of a corporate retirement plan. This severe Federal estate tax inequity is further compounded for nonincorporated individuals because. most States in our country im- pose their own inheritance tax in addition to `the Federal estate tax. The total area of tax inequalities and in~onsistencies pertaining to retirement plans was published in great d~tail in the Boston Herald- American on Labor Day 197~ entitled, "~d~ded Tax Reform Urged for Those Under Noncorporate Retirement~Plans." A copy of the Boston Herald-Ameri~au article is enclosed ~o that you will have a better frame of reference regarding othei~ ta~ inequalities. It is obvious that even with the liberalization of Keogh as to increased deductible amounts, and the crea~ti'on'of IRA as part of the Pension Reform Act of 1974, Congress still has not gii~ th~ self- employed and Other individuals, not covered wider a retireme~t plan, the best that is available under existing law, I appreciate the prhrilege of appearing here today. I sincerely hope that my testimony will enable you, as a committee, to recommend legislation to be introduced and passed,' to end the severs diserlinina- tions and inequalities that affect Keogh and IRA plans.' Thank you very much, Mr. Chairman.' Mr. BURL~SON. Thank you.,' [The following additional material was supplied:) tFrom the Boston ~Iera1d.Amer1can,,Sept, 1, 1975] Anmnn TAX Rxroi~ ~geni roi~ Tuosa Tjinna NoNcoRronAva RErmF~MENT PLANS (By Richard Lamere) Severe tax inconsistencies and other inequities militate aga1n~t various types Of retirement plans as opposed to "favorable treatme~t'~ for corporate retire. inent plans, a Boston life 1nr~iiranee executive charged yesterday~ PAGENO="0796" 782 On the anniversary of the enactment of the Pension Reform Act of 1974 in Washington, William D. Browulle called for additional tax reform because "the self-employed and other individuals are not receiving the same beneficial tax treatment as their counterparts who are covered under corporate retirement plans. "There is still much to be done, and this can only be accomplished In tax reform legislation," Brownie declared. The legislation enacted last year allowed for the tax deductible contribution to an individual retirement plan to be ii~creased from $2500 to $7500 annually in the tax-sheltered Keogh-tyype deferred-compensation plans. It also, for the first time, allowed employed individuals, not covered under any pension plan to have their own Individual Retirement Account referred to as IRA, and to be able to contribute a maximum deductible contribution of $1500 per year. "Millions of Americans who are investing their tax-deductIble dollars into either Keogh Plans or an Individual Retirement Plan for their own do-it-your- self retirement plan are not getting the same tax consideration as those covered under corporate-type plans," stated Brownlie. "Now Is the time for Congress to enact legislation to end discrimination and injustices that adversely affect millions of Americans each year." Brownlle~ who plans to testify as a private citizen at hearings before the House Ways and Means Committee in Washington, insists that severe discrimina- tion and Inequality exist among corporate retirement plans, Keogh and IRA plans In the following &reas: federal estate tax treatment, federal income tax treatment, integration with Social Security and life insurance. The first injustice, he said, occurs' if a self-employed `person Such as an architect or ~pharmacist creates either a Keogh Plan or IRA Plan `and dies before retirement "because the entire value of the plan is Includable In his estate at the time of his demise." On the other hand, Brownlle said not one penny of a corporate retirement plan Is subject to the federal estate tax if payable to a named beneficiary, such as wife, children, parents, brothers, ~1sters or personal trust because of Section 20fi9 of the Internal Revenue Code. Thl.~ section provides federal ~state tax exclusion fOr corporate plans, but does not provl~e it for the self employed individual under the Keogh Plan or an IRA plan, Brownie stressed. Another inconsistency Brownlie said, Is that the empio~e of a self-employed Individual, under a Keogh Plan~ Is entitled to federal estate tax exclusion. "What makes it right for the employe and wrong for the boss?" he asked. Llf~ Insurance proceeds, which could amount to many thousands of dollars, are OxOmi~t from the federal estate tax for corporate plans. This federal estate tax exclusion is riot available for Keogh or IRA plans. "Because a Keogh Plan could be worth hundreds of thousands of dollars, it is essential for additional life insurance to be purchased for the sole purpose of providing money to pay federal estate taxes," Brownlie said. Another Injustice, he said, is that corporate retirement plans also provide for a $5000 Income tax-free, death benefit, which is not available for either the Keogh or IRA plans. A `third Injustice pertains to Social Security integration, Said Brownile, who fo~ several years has stressed "tax inconsistencies In lectures and national con- ferences and in his monthly column Insurance Tips written for the publica `lion, ~`Massachusetts Physician." "Simply stated," Brownlie said, "a corporate employer can reduce the amount of money he contributes to a corporate retirement plan for his employes because he is allowed to take into consideration the fact be is already contributing on their behalf to the Social Security retirement system, "This also is not available under the existing rules for a vast majority of Keogh plans." A fourth injustice, Brownlie contended, pertains to the Income tax treatment of life insurance premiums, which can be purchased on a tax-deductible basis as part of a corporate retirement plan, as well as part of a I~eogh plan or IRA. plan. When life insurance is used in a retirement plan, a percentage of the premium is subject to federal income tax for all participants. This applies to corporate, `Keogh and IRA plans. `However, under a purely corporate plan, when a participant retires, he gets an income tax credit on the total percentage of the premiums that were subject to PAGENO="0797" 783 federal ii~ec~rne tax during the life of bis p1a~i, and~hLs f~rnily g~ts the same 1n~othe tax credit when be dies. ~ ~ This income tax erxlit, inifertunately does not apply to ~e~ogh or TEA plans, either at retirement or at death-anothar ln~ons1steney," Browr~lle stressed The most notable ineons!stenoy~ pertaiatI1~ to life Insaranee w~tbin retirement plans Is found in the IRA p'an, Browniie said Under existing law, onl~r an endowment type ô~ life insurance polley ean 1* used within IRA. ~ ~ . `This type of life insnran~e policy, ` contended Brownile purchases ver3r ]~t tle in~nrance protection for the money ~pent Tins is Inconsistent with what is allowed for corporate and Keogh plans wherein these plans allow for the typical cash value qrdinary life policy or the ecottomatic type policy Which iDurchasce much higher lIfe Insurance protection for the same money Spettt "IRA plans should be changed to allow for the same type of life Insurance protection that Is permitted for corporate plans and Keogh plans Two months ago Brownlie spoke on the subject of Keogh plans at the insurance industry's "Million Dollar Round Table" annual meeting in San Franeis~o, out lining his experiences designing and serviciug Such plans. STATEMENT OP DONALD 0. SMITB Mr. SMIm. Mr. Chairman and members of the committee, I am ad dressing my remarks also to the Federal estate tax credit for State death taxes However, my remarks will have somewhat different em phasis from those of Mr Roister, and I propose a different solution to what I see as the problem in this area As you gentlemen know, the Federal estate tax credit is a dollar for dollar credit with respect to State death taxes imposed on the es~ tates of decedents domiciled within their jurisdiction. There is a limit to this credit, however. 1 shall discuss that later. It is the only adjustment allowed under the Federal estate tax for the tax imposed by a State )urlsdlctlon It is ilriportant to bear in mind-as is conunonly knownL_~_that there is no deduction for a State death tax against the Federal estate tax Many witnesses who have appeared before these hearings have pointed out how severe a burden the Federal estate tax, as they presently exist, imposes on our citizens The burden is certainly heavy enough to leave little for the States to tax in many cases. To take an extreme example, the highest Federal estate tax bracket is 77 percent The result of this is that each 1 percent of added State tax `at that bracket consumes over 4 percent of the estate that remains after the Federai~tax. This committee must be acutely aware, more so even than I, of the problem that the States have in collecting roveriues from their citizens, within the framework of the Federal tax that we now have. The States as you know have been driven, to tax homes and purchases and even meals and in Massachusetts, my State, we are running a little gambling establishment inthe form of a State lottery. These pressui~s on the States make all adjustments that are fur~ nished by Federal taxes a matter of the most ~ritieaJ concern to the States in establishing theft own tax policy The failure ~f any Fed eral tax to establish appropriate adlustmonth compounds the problem of the States in deriving fair revenues from their citizens Lot me give you a simple example-and I have furnished a written statement which I hope may be incorporated in the proc edihgs of the committee. PAGENO="0798" 784 `Mr. BURLESON. Your full statement will be included, Mr. Smith. Mr. SMITH. In that statement there are many other examples and statements which will confirm the points I am endeavoring to make, A simple example would be an est~ate of $1 million which was planned appropriately under the marital deduction piov~sions of the Internal Revenue Code as it exists. What does the Federal credit allow to the States by way of a shared revenue? From this estate of $1 millio'wabout 2 percent of the total taxable estate~ or $20,000., How can a State establish an appropriate tax plan when the frame- work of the Federal credit allows as little as that thropgh the form of the credit, and with no deduction to assist in that regard? It is enough to say accordingly that the credit furnishes precious little by way of assistance in many cases to the States. But what I find more puzzling, although there is a historic explana tion for this-as Mr. Reister pointed out-is that the~ credit is higher proportionately in the larger estates than it is' in the smaller estates. Can this be justified? Why should it be true? Clearly it benefits those few States with the largest estates. And indeed in a certain sense it seems to take taxes from poor States'to give to the rich. Something must be wrong here unless there is some clear policy reason why this disproportionate rate structure should exist. I think you will find that it exists for historic reasons `and none other, and I hope you may conclude that the problem needs to be examined to see whether the credit should be restructured to avoid these anomalie~. The simple faèt is that the Federal credit is not a significant or appropriate adjustment in Federal taxation with respect to estates of up to $500,000 with no marital deduction, up to $1 million and more with a marital deduction, and I have simply taken an arbitrary cutoff line because those happen to be the points at which the credit exceeds 2 percent of the taxable estate. Two percent is hard'ly generous. Most States-many States I guess I should say~-have been driven to impose added death taxes on top of the Federal estate tax credit in order to secure fair and appropriate revenues from estates. I. point out to you that insofar as that has happened, a double tax is imposed on the estates in~the smaller brackets, but not so much in the larger ones be- cause of the large credit relatively speaking which is afforded in the larger estates. This seems unfair to me. It seems to me that this leads to competition `among the States for revenues from their citiZens, I disagree with Mr. Reister in the proposal I would offer to cure this problem. My proposal is a simple one. It is a proposal that would simplify the tax law. The proposal is simply to restore the credit towhat it originally was, a fixed percentage of the Federal tax. I have recommended that the credit be restored to a 25-percent rate, and those whø take pleasure in history will find that this was the original credit percentage. It is also close to 5 percent more than the effective' rate with respect to the largest estates under the Fedreal credit now. But you may be sure that it is a great deal more than the effective rate with respect to the smaller estates. It is high enough so that no State conceivably can lose any revenues by virtue of the change in the manner of sharing revenues. I also propose for consideration the possible addition of a deduction for State estate taxes insofar `as State death taxes exceed the amount PAGENO="0799" 785 o~ th~'F èr~c~cl~The. reasó~ isto ai~oid a d~ub1e tax o~theest&tes to the ~xtent~auckaddedtaxes iu~e needed, ~i~ially, iE the credit isto~be studiedandconside~'ed at this tim~ I would rceOmrr~end that a credit for State gift taxes also be added to the law. I can think of ~o réas~ii i~we are goiig~toh~ve a Federal~cr~dit for e$tate ta'es, why ~ si~mti~ar credit ~Qr S~te~ gi~t taxes is not al~ together appropriate andfair. Ithank you ~ery much. [rIhe prepaz~ed statement follows:] STATEMENu O~' ~O~AL1~ 0. SMITh, ~OSTOx, i\iASS XNTEODUCTXO~ The federal estate tax, under ~ect1on 2011 of the Code, allows a credit for state inheritance, legacy, succession and estate 1a~es o~ the same estate, `J?1u~ credit is allowed in full, dollar for dollar, for the state death tax imposed, It can be said at the outset that a state death tax can be assessed without cost to the taxpayer: the Federal Government bears the entire burden up to the limit of the credit. ~t is not surprising that all the states-even those that are most conserva- tire ln~ their taxing poiicles-~hava imposed death tazés to the full extent of the federal credit. The limit of the federal credit is determined under `a separate table which applies at graduated rates to the taxable~estate as defined for purposes of the federal estate tax. The r~ltes and exemption of the ctedit were established in 1926: they have not changed since then, though the rates of the federal tax have ~dnce mtiltlplied. We thus now have a1926 adjustment for state taxes applied to a radlc~1ly changed 1976 tax structure. it would be remarkable If the old credit and the new tax meshed with logic and fairness to all under these circumstances. ROW TUE FEDERAL CREDIT WORKS * As it existed in 1926, the federal credit was proportional to the federa~1 estate tax Imposed. As stated, the rates and exemptions o~ ,th~ credit have not changed. Since 1926, the federal estate tax rates have increased, b~tt. not pro~ortlonately at every bracket. The increases at the lower brackets were far greater (4% to 30% or 7~ times, for example) than those at the higher brackets, (20% to 77% or 3.9 times). In addition, the exemption for the federalestate tax has decreased from $100,000 to $60~000.' a result of the decrease of the tax ex~~pt~on and ot1i~r cb~nges, mafly estt&tes which now pay a federal estate tax produce no creTdit~or state death tazes at all. As a result of the rate changes, smaller estates pay a much higher estate tax, but prod~uced the same credit that they did In 1926.. ~I'hc ~amé~is true of the laxge~,estait~~_bu~ those estates now produce a much higher credit, in/proportion to the estate tax, than the smaller estates. The present variations "in credit amounts and ratf S is shown, by the annexed table. For example, the credit for an estate of $2~0,00Q is $2,400 (column 3) against a federal tax before credit of $47,700 (column 2). The effective credit rate (measuring the credit against the federal tax before credit; as it originally was) is 5% (column 4). The credit ~or an estate of $5,000,000 on the other hand, is $391,000, against a federal tax before credit of $2,430,400, and the credit rate over 16%. As column 4 M the table shows, the effective credit rate, still in terms of the credit meastired against the federal tax before credit, ranges from 0% (because the exemption for the federal tax is $40,000 less than the effective exemption for the credit) to 19.4% and up to~á theoretical hiniit'appro'aching 20.8%. The variations in amounts and rates shown on the table for a marital deduction estate are even greater. The term marital `deduction estate requites explanation. In 1948, to eliminate a tax a4vantage available In residents of community prop- erty states, the estate ta,x law ~was ~ to afloW a ma~rltal~ deduction that permitted the estate of one spouse to'be treated in eite~t as if it ~vas owned e~uahly by both spouses.. The estate of a married c~~p1~ ~ss,1ng to children or ~ithier per- sons, js therefote taxed with the exemptiohfánd' lowet rates applicable to two separate estates, each Of oiie-h~à1f'the t~tal. rt `is likely that a majority o~ the estates of married persons are taxed `in this manner. * " PAGENO="0800" 786 The zuarital deduction resuitsln a much smaller federaltax m estates in the lower to middle brackets (compare the tax amounts shown In cc4t~tnn 2 wIth tbo~ shown In column 7). The proportional effect on the largest estates Is not as great. A similar pattern, magnified by a larger exemption arid by tke greater rate tim crepdncies at the lower brackets occurs In the federal credit for state taxes Consequently, a far broader range of estates now tall Into the zero credit and low-credit brackets, as shown by comparing column 9 with column 4. For example, the credit for a marital deduction estate of $250,000 ts'$400 (column 8) against a federal tax of $21,800 (column 7), with an effective credit rate of 1.8%. On an estate of $5,000,000, the credit is $277,600, the federal tax Is $1,937,600 and the credit rate 14.3%. A comparison of the credit with the taxable estate aids in Identifying the estates that contribute significantly to state revenues under the credit. Columns 6 and 11 show that estates up to $500,000, and marital deduction estates up to $1,000,000, contribute 2% or less to state revenues by reason of the federal credit. Remember- ing that the federal estate tax usually exempts accumulations under qualified pension and profit sharing plans it seems likely that the estates of most sue ~essfuP exeeritlves,profèssioitais and entrepreneurs contribute only token amounts to state revenues thi~ough the credit. GFINEEAL COMMENTS In 1926, the federal credit f~v state death taxes bore a logical relationship to the fOderal estate tax: It was In direct proportion to the revenues received by the Federal Government. That may. not have been the best method of revenue shar- ing but It is difficult to see how the present method represents an improvement Revenues are now shared in an Increasingly d~sproportlonate manner according to the location of the largest estates The credit thus favors those states whic1~i have `or succeed `in attracting the wealthiest residents. TbIs tends to. encourage the interstate competition for revenues which. the credit was once expected, to ameliorate. The federal estate tax marginal rates on the largest estates and incomes are high enough to encourage heroic efforts in the avoidance of additions through state taxation. A state's addition, over the credit, of a 1% tax on assets in the highest federal estate `tax bracket consumes over 4% of what remains after the federal tax. All state ~ddittons to the federal estate' tax can' be avoided by a change of domicile from one state to another, though the federal tax generali~ Cannot be avoided even b~ emigration to a foreign country. A state which loses ~ large estate to taxation loses all of the federal credit, together with income taxes, property taies and'other benefits. These considerations suggest that the higher credit rates on the largest estates may be more critical to the maintenance of' sound state tax policies than are the rates on the smaller estates. Rut today, the owners of smaller estates nrc more sophisticated in tax matters and more able to shop for tax-haven domicileS than they ont~e were. Federal aid to the states In collecting fair death tax rev- enues from all theii~ eit1zE~ns, through increase in the credit at lower brackets, Is an increasing necessity. Above all, the structure of the federal credit should be fair, and without dis- crimination among taxpayers or states that are not justified' by clear and sound policy considerations. That does not appear to be the case. PROPOSAL The effective rate of the federal estate tax credit for state death taxes should be restored'"to a single rate applied against the federal tax. A 25%' rate would restore the credit to an appropriate level for the smaller estates, without produc- ing a major revenue loss from the larger estates. Addition of a deduction for state taxes above the credit amount would eliminate the double tax which otherwise occurs. THE FEDERAL GIFT uAx AND SPATE GIFT TAXES There is no credit again~t the federal gift tax for gift' taxes imposed by thO states. It may be surprising that a minority of the states have gift taxes, despite the consensus' that an effective death tax system requires a gift tax to prevent tax avoidanCe. Doubtless the federal gift tax has discouraged wholesale ta~ avoidance' by gift, sufficiently to make state gift taxes unnecessary for that purpose; but the fact remains that gifts are an i~creas1ngly-used method of tax reduction. PAGENO="0801" 787 Gifts contribute nothing to the revenues of most of the states, though they re- thice taxable estates for federal purposes and, in turn, the federal estate tax credit for state taxes. Every consideration of symmetry and fairness calls for the allowance of a federal credit for state gift taxes. Percent Marital ded uction estates: total taxes and cr estates of both spouses edits on of Percent Percent Federal of of credit tax Percent Percent Federal to after of credit tax Percent Taxable Federal credit credit to after of estate Federal tax to Federal credit credit before exemption estate tax before credit *Credit for State taxes before credit taxable estate taxable estate Federal estate tax before credit tax to Credit for before taxable State taxes credit estate to taxable estate 1 2 3 4 5 6 7 8 9 10 11 60,000 120, 000 9, 500 160 1. 7 7. 8 1 150, 000 17, 900 400 2. 2 11. 7 . 3 2, 100 1. 4 200, 000 32, 700 1, 200 3. 7 15. 8 . 6 9, 600 4. 8 250,000 47, 700 2, 400 5. 0 18. 1 . 9 21, 800 400 1. 8 8. 6 . 2 300,000 62, 700 3, 600 5. 7 19.7 1. 2 35, 800 800 2. 2 11. 7 . 3 400,000 94, 500 6, 800 7. 2 21.9 1. 7 65, 400 2, 400 3. 7 15. 8 .6 500,000 126, 500 10, 000 7.9 23.3 2. 0 95, 400 4, 800 5. 0 18. 1 1.0 750,000 212,200 20, 400 9.6 25.6 2. 7 173, 000 12, 000 6. 9 21. 5 1.6 1,000, 000 303, 500 33,200 10.9 27. 0 3. 3 253, 000 20, 000 7.9 23. 3 2.0 2,000, 000 726, 200 99,600 13. 7 31. 3 5. 0 607, 000 66,400 10. 9 27. 0 3.3 3,000, 000 1,231, 400 182, 000 14.8 35. 0 6. 1 1, 006, 000 128,800 12. 8 29. 3 4. 3 5,000, 000 2,430, 400 391, 600 16. 1 40. 8 7. 8 1,937,600 277,600 14. 3 33.2 5. 6 10,000,000 6,042, 600 1, 067, 600 17. 7 49.8 10. 7 4,860, 800 783,200 16. 1 40. 8 7. 8 2Q, 000, 000 13, 742, 000 2,666, 800 19.4 55.4 13.3 12,085,200 2, 135, 200 17. 7 49. 8 10.7 Mr. BURLESON. Thank you, Mr. Smith. Mr. Pickle. Mr. PICKLE. Mr. Chairman, if you will yield to me, I was not able to be here when Repersentative Hubenak presented his testimony. He is one of the most prominent members of the Texas Legislature. His district and mine adjoin each other and we are usually at the same hustings. I know he is recognized as one of the outstanding agricultural experts in our part of the State, and is recognized na- tionally by virtue of his action on the National Conference. I will read the testimony, Mr. Hubenak, and appreciate your com- ing here to testify for this measure. I realize that you feel that the small farms are going to get smaller and go out of business unless we give them some relief. Mr. HtTBENAK. That is becoming quite evident, especially in the district you and I jointly represent around the Katy area where Huston is encroaching upon us at a rapid pace. There is just no way that you can have land at $10,000 an acre like we have in the Denton area and also the county area and have the children all stay down there. As I stated earlier, the average age of the farmer is 51 today which pretty well tells the story that the young people are not remain- ing on the farm where they really ought to be. I would have been there but for that, if I had that opportunity, but I don't have the money. Mr. PICKLE. Are you quoting your age? Mr. HUBENAK. Thirty-eight and counting. Mr. PICKLE. Well, we are glad to have you here and I welcome you to the committee. Mr. S~rEIaE~. Mr. Chairman. 08-872-76------51 PAGENO="0802" 788 Mr. BURLESON. Mr. Steiger. Mr. STEIGER. Mr. Chairman, let me say to your Mr. Brownlie that your testimony has been singularly helpful, absolutely on target; you have pointed out an oversight that must be corrected. I am grateful to you for calling it to our attention and I think you will see that we will address the problem. It has been interesting to me as I have listened, and the gentleman from Teaxs, who has been so deeply involved, Mr. Burleson, in this whole field, and has been a leader in this whole field. This is a subject that is exceedingly complicated. Oftentimes at first it appears to be dry, but I must say to this panel, as with the other panels that we have had through the beginning of these hearings, that you have been extraordinarily helpful in shaping our learning on something we have not dealt with at all, and need to deal with most desperately. I appreciate deeply the fact that you have all come and have given us the benefit of your testimony and especially appreciate your having been so patient with us and with the Congress. Mr. BURLESON. Are there other questions for the panel? Mr. JACOBS. Yes. Mr. BURLESON. Mr. Jacobs. Mr. JACOBs. I am sorry I stepped out of the room for the moment but I just wanted to express the gratitude of the committee for the kind words of the panel about our colleague, Mr. Burleson, who also is not only from Texas, but Indianapolis, md., by way of working there for the FBI once, let the record show. Mr. BTJRLESON. Well, I thank my colleague very much. That makes me a cosmopolitan. Gentlemen, thank you. Mr. BEOWNLIE. Mr. Chairman. Mr. BTJRLESON. Mr. Brownlie, go ahead. Mr. BROWNLIE. I just want to make one more comment about the unfortunate second-class citizenship of Keosh. I represent many States, particularly in States particularly like Massachusetts, which do not allow the Keogh contribution of $7,500 or less or the maximum IRA contribution to be deductible on the State income tax return. This is true in many States I believe in the United States, and I attribute this mainly because the Keogh and IRA do not have the same Federal corporate tax provisions. It has always had a second-class status in the United States, even today. Mr. BURLESON. Thank you again, Mr. Brownlie. Mr. BROWNLIE. Thank you. Mr. BURLESON. We thank the entire panel for their contribution. Mr. HTJBENAK. Thank you, Mr. Chairman. Mr. BURLESON. You have been most generous. Our next panel is that of the American Agri-Women and Wisconsin Women for Agriculture. Will those on this panel please come to the witness chairs. Marcellus Vogel, Doris Brandl, Audrey Sickinger, Mrs. Lloyd Royal, Helen Rafert, Alan Bock, Laura Lane, Rev. George Chauncey, and Jacque- line J. Furber. You will constitute the panel. Mr. Sn~naER. Mr. Chairman, before you go any further I would simply want to recognize Jo Ann Vogel, who is here and will have PAGENO="0803" 789 the chance for the second time, if I remember correctly, to testify before the Committee on Wa~ys and Means. Jim Jones and I when we were in Sheboygan had the pleasure of having met her there. I look forward to her testimony and I am delighted that she is here representing Wisconsin Women for Agriculture. Mr. BURLESON. Are you all identified? Well, perhaps not yet. On our agenda Mrs. Vogel is the first witness. A PANEL CONSISTING OF MARCELLUS (JO ANN) VOGEL, DORIS BRANDL, AND AUDRY SICKINGER, REPRESENTING AMERICAN AGRI-WOMEN AND WISCONSIN WOMEN FOR AGRICULTURE~ MRS. LLOYD ROYAL, SPRINGFIELD, NEBR.; HELEN RAFERT, GRESHAM, NEBR.; ALAN W. BOCK, DIRECTOR, LIBERTARIAN ADVOCATE; LAURA LANE, PHILADELPHIA, PA.; REV. GEORGE A. CHAUNCEY, CHAIRMAN, INTERRELIGIOUS TASK FORCE ON U.S. FOOD POLICY; AND JACQUELINE J. FURBER, WOLCOTT, N.Y. STATEMENT OP JO ANN VOGEL Ms. VOGEL. My name is Mrs. Marceflus Vogel (Jo Ann). We farm 275 acres in Manitowoc County, Wis. We have 150 head of cattle of which 70 are milk cows. We have four children ages 16, 15, 14, and 9. I am testifying here today representing American Agri-Women, a national organization of 2,000 members concerned about the future of agriculture. We as women are unjustly discriminated against by a law written in 1942. At that time the Consumer Price Index *as 48.8 and in December of 1974 it was 155.4, which means the pur- chasing power of the dollar has `been reduced by 68 cents. Agricul- tural land in our area sold for $100 an acre; that same land today would sell for $800 to $1,000 an acre for agriculture. Something must be done about this law. It is archaic and derives from old English law. That looked upon a women as a servant being owned by her husband. Once a women signed a marriage certificate she `became the property of her husband. In many respects women are still treated by law in this manner. I am not a woman "Libber." Farm women have always been liberated. We have always had the opportunity to do any work alongside our husbands we would or could do, whether we were bearing our children or not. All farm women help their husbands whether it is driving trucks hauling grain, apples, peaches, et cetera, or doing the bookwork and many other errands on a farm too numerous to mention. To give you an idea of why I feel so strongly about changing this law, I would like to tell you about my life since I have `been married. My husband and I were married 17% years ago. I have helped my husband every single day all day and many times far into the ni~ght. The only exceptions have been 4 or 5 days to have each of our four children, and I might add we also raised four foster children over a period of 9 years, and 7 other days for business. We have never'had a vacation and we work 7 days a week. My day begins at 5:30. I make breakfast for our children and pack lunches, PAGENO="0804" 790 call them for school and then go to the barn where I feed and milk cows, feed calves and heifers. Then I go to the house at 9:30 and make breakfast, clean the house and start supper. By 11 :30 I must go back to the barn to do other chores and if everything goes all right with no breakdowns I will be in the house by 3:30 to finish supper. We have supper at 4:40, I do dishes and go back to the barn at 5:30 until 8:30, and during the summer many times until 11, 12, or 2 at night. Our children help us in the barn every night, every weekend and all summer. During harvesting and planting seasons all chores must be done plus all the fieldwork. Then I will help in the field. I must know how to drive every tractor and use every piece of machinery. Besides this I do all the bookwork and banking for our business. My sister-in-law laughingly asks, and I am the only one of nine children on a farm, "How can you stand each other all day every day ?" I say, "It ain't easy." Yes, I am indeed a partner in every way possible. I know and feel the grief, anxiety and disappointments of being stewards of the land and providing food for the world. In the eyes of the law we women that work alongside our husbands are considered not contributing to an estate. The only way a contribu-~ tion is recognized is if we had worked outside the home and could prove it. I am allowed $60,000 plus one-half the gross estate-Why? When I have worked all my married life forsaking other employment to help my husband. If I did not we could not farm as efficiently as we do, and my husband tells me this every day, that he could not do it without me. Therefore we would not pay as much in Federal and State income taxes. It seems peculiar to me that I must pay estate taxes upon the death of- my husband when we have paid for the farm by my labor as well as his besides paying interest, income taxes, State and Federal, and property taxes every year. As I see it there is on1y one advantage to this law. The wife should die first and then the husband could collect her life insurance, if she had any, and bury her in a manure pile, if he had one, and that would be the end of that, and that is exactly the way many of us feel. If my husband died tomorrow and left a taxable estate of $300,000, which we do have, the taxes would amount to $36,700. Federal, State and other expenses would be another additional $20,000. Besides this daily expenses must be met. Like most farmers we do not have a savings account and we do have debts. Everything we make goes into our business. Therefore, I would have to dispose of some property. I would have no choice. Estate taxes must be paid in 9 months. We of American Agri-Women believe that it should be extended to at least 18 months because many crops cannot be harvested and sold in 9 months time. We also believe that the exemption should be raised to $250,000. My personal feelings are that there should be no estate taxes between spouses. The Burleson bill, H.R. 1793, has many good points. In particular the elections of classifying land and raising the material deduction by $100,000. We think it is an excellent idea and it would help. Land used as agricultural land is only worth as much as it produces. It cannot be or should not be assessed as land that could be developed. We PAGENO="0805" 791 think it is very important to keep all agricultural land intact and this is one way of helping. A sincere thank you for your kind attention and for the opportunity to appear here today in behalf of American Agri-Women. Thank you again. Mr. BTJRLESON. Thank you very much, Mrs. Vogel. Mr. Steiger, let me just call to our attention this girl looks real well to work so hard. Mr. STEIGER. She has four children, does all that work and also does an incredible amount for Wisconsin Women for Agricult~ire. She certainly works more than full time. I am going to find out her secret so we can all share it. Ms. VOGEL. Run fast. Mr. BURLESON. Thank you again. Ms. VOGEL. Thank you. Mr. BTJRLESON. Now we will hear Mrs. Brandl. STATEMENT OP DORIS BRANDL Ms. BRANDL. I am Mrs. Harold Brandl (Doris). My husband and I own and operate a 220-acre dairy farm in Manitowoc County, Wis. I am testifying in favor of the Burleson bill, H.R. 1793. All farmers and small businesses need the tax deductions contained in H.R. 1793. There has not been a change in the tax structure for these people for many years. Not since the 1940's. The present personal de- duction has not been changed since 1942 when it was raised to $60,000. The cost of land has risen as much as 500 percent since that time. In some instances more than that. The cost of keeping the farm up to proper production has also risen tremendously-like 500 percent when we purchase farm machinery and supplies. The most important part of this bill to us will be to enable my husband and 1 to keep our farm in our own family if it is the desire of one or more of our children to own and operate it. We do not,, and what farmer does, have a savings account to adequately cover the price of an estate. By this I mean to have enough money to pay out to their other children so one or two sons can own and operate the farm. To use my own family as an example, we have eight children, ages 4 to 25. Our farm is valued at about $250,000. Until the debts are paid and the children given an equal share, I would have to sell our farm upon the death of my husband to settle the estate. When we talked to our lawyer about a will and estate planning he said, "For tax purposes even if a farm is in joint tenancy the husband is considered to be the proprietor." I would like to know what I have been working for alongside my husband for the last 27 years. I have worked in the field, all day, did my housework at night when my chil- dren were small, took them along in the fields or rode them on the tractor. There has been very few times that I have missed milking. I have helped repair buildings and machinery when needed. I do book- keeping and keep the records on cattle, et cetera. Even if all farm women don't do all of these chores, they do know what is going on by helping with recordkeeping, doing errands such as getting parts for machines during harvest time and just by the gen- eral knowledge she has to have. 68-8720-76-52 PAGENO="0806" 792 If the $200,000 personal exemption is passed, as in the Burleson bill, H R 1793, it will also help a ~oman to continue to farm if she desires to do so It is estimated that less than 2 percent of revenues come from estate taxes I suggest closing other tax loopholes to make up this difference, some of which are deliberately made I also endorse the proposed definition of real property and the 60 months preceding the date of death as it pertains to the use of f arm- lands I would hope this will help keep land in farming and if it does not theye would be back taxes or a penalty to pay The production of food is one of our country's most important in dustries Farming is a part of America, it is a way of life Let us help to keep it that way. Thank you for this opportunity to testify Mr BURLESON We thank you very much, Mrs Brandi We have been very interested in your statement Ms BRANDL Thank you Mr BTJRLESON The next witness is Ms Sickinger We will be glad to hear you, Ms Sickinger STATEMENT OF AUBREY SICKINGER Ms SIcKINOER Mr Chairman, and members of the committee, my name is Mrs Jerome Sickinger (Audrey) and I reside at Route 1, Cato, Wis, with my husband and family My family consists of seven chil dren, five girls and two boys We farm 1,800 acres in Manitowoc County growing corn, oats, al falfa, and some vegetable crops Our Holstein dairy herd consists of 500 head with 275 of these being milk cows I am a member of the Outstanding Young Farmer Fraternity which has over 800 members in every State in the United States We appre ciate this opportunity to offer testimony and to be heard on our views of support for the bill, H R 1793 The estate of these farmers run in excess of $1 million The law passed in 1942 setting the general exemption of an estate at $60,000 is, we feel, in need of change The bill, H R 1793, suggests a $200,000 exemption which would be more realistic H R 1793 states that the marital deduction of one half the estate be increased over and above this exemption by another $100,000 This, too, would be a realistic figure We would also agree with the election methods stated in H R 1793 of appraising real estate property according to the use of this land If the land is sold for another purpose within a 5 year period, we agree taxes should be paid on the value for which it was sold We further feel that the time allowed, 9 months, is not long enough to settle an estate in operations of this size and be able to continue efficient operation of the farm We, therefore, suggest, an 18 month period in which to pay the taxes which are due I have been married 23 years to a farmer, starting my day at 4 30 each morning. Heading to the barn to milk and feed the cows and care for the new baby calves before breakfast at 7 a.m. Our children must accompany us in order to get the work done and then hurry to be ready PAGENO="0807" 793 for school. Our cattle are housed in five different sets of farm buildings. The remainder of our day is spent traveling to each farm to feed and care for these animals. We have worked diligently and daily to increase our farm operation. Today, besides our family, we do have hired hands. We like our work and feel we are doing a good job. Our boys, 15 and 14, would like to continue farming after school. At this time should their father die it would create many hardships and the possibility of farming could be negative. Much of the estate would have to be sold to settle the estate taxes. The possibility of our daughters farming is also quite probable, as their interest and knowledge of agriculture is there and instinctive. Sandy, 19, attends the University of Wisconsin, Manitowoc Center, as a sophomore in the Agriculture and Life Science College, majoring in bacteriology. Debby, who is 17, graduates in June from high school. She plans to enter the Agriculture and Life Science College of the University of Wisconsin and major in dairy science with a strong inter- est and desire to be a veterinarian. I, myself, am a farmowner and operator in Manitowoc County in addition to being a farm wife. To continue the farm operation after my husband's death would not be an unreal situation. Therefore, I support the changes in the Burleson bill, H.R. 1793, on the point that the old law of 1942 discriminates against my ability to efficiently manage a farm operation because I am a woman. The average Wisconsin farm of 185 acres with 41 cows and machin- ery is said to be worth $185,000. This is the latest figure by our Wiscon- sin Department of Agriculture. This is figuring land at a value of $451 an acre. Just last week two farms adjoining ours sold for over $800 an acre. This rate of inflation plus insurance policies of the average farmer in Wisconsin would put his estate far past the general proposed exemption of $200,000. As a member of the government regulations committee of the Ameri- can Agri~Women and vice president of Wisconsin Women for Agricul- ture, I feel a need to support changes in ou~ country's estate exemption laws. I thank you for the opportunity to appear here before you today and ask that you consider some new provisions for our outdated estate tax law. Thank you. Mr. BURLESON. We thank you, Mrs. Sickinger, for a very interesting statement. Ms. SICKINGER. Thank you. Mr. BURLESON. Next on the panel is Mrs. Lloyd Royal. We will be glad to hear you, Mrs. Royal. STATEMENT OP MRS. LLOYD ROYAL Ms. ROYAL. Mr. Chairman, two other witnesses on this panel, Laura Lane and Helen Rafert, have agreed to take less of their time in order for me to more fully cover the material that I have set forth, if this is agreeable to you. Mr. BURLESON. That will be satisfactory, and their full statements will be included in the record. PAGENO="0808" 794 Ms. ROYAL. Mr. Chairman, and members of the committee, I would like to present Mr. Bill Jones and Senator Dennis Rasmussen, who will help me with the questions that you may have that I am unable to answer. In the interest of time I will not follow my prepared statement word for word and also I will make additional comments for clarifica- tion. Please insert the full statement in the record. My name is Mrs. Lloyd Roybal of Springfield, Nebr. My husband, Lloyd, and I own 240 acres of farmland and rent another 80 acres in Sarpy County, Nebr. We are family farmers in the true sense of the word with both of us working in the farming operation. Today I am presenting two petitions containing 130,051 signatures in three boxes to Chairman TJllman and members of the committee. Others were sent directly to Washington. Also, an additional 5,000- plus signatures have arrived at my home since I left for Washington. These will be presented at a later date. It is still hard to believe that a simple campaign by three women to arouse their county could spread across the entire TJnited States with- out receiving any dissent. These petitions have been gathered in 48 States. I also am presenting copies of letters and quotes of other letters which I want to be inserted into the record. Mr. BTJRLESON. They will be included in the record. Ms. ROYAL. This to me is very vivid proof that the law is in need of change. I am not a women's li:bber. However, when I found that the IRS didn't recognize the contribution of a spouse, it was a feeling of dis- belief. To think that spouses can work together for so many years and be told only one of them had earned the estate. it is unreal. I firmly believe that in middle-class families there cannot be much of an estate unless both spouses help. It is easy to spend, difficult to save. There is no logical reason why work should not count as a contribu- tion. I, and many others, can and do operate almost every piece of machinery on the farm. Just this last summer, my husband was hos- pitalized during cultivating time. This menat one tractor in the field instead of two. My hours went from 4:30 in the morning until 10:30 at night. To us, I made a contribution to our net worth. Why not to IRS? What difference should it make if I drive the tractor or work in town for wages with which to pay a hired hand? Every husband that I came in contact with declared emphatically that their estate would not be as large if it had not been for the help of their wife. This is not just a farm problem. In Springfield almost every business is family owned with the wives helping. * I am very pleased to see that H.R. 7521 has been introduced by Rep- resentative Charles Thone and S. 2879 by Senator James Pearson, in an effort to change this injustice. These bills were selected because I do not think a single monetary figure can apply. Contrary to articles stating there really is no problem, farmers and businesses are having to sell to pay estate taxes. One of the saddest cases I have heard is a farm that was given to a son by his father many years ago. It was small and when the son died, it was not enough to PAGENO="0809" 795 keep his widow. Her daughter and son-in-law contributed much to her upkeep. The widow died recently. The daughter's husband died shortly after. The doctor bills, funeral bills, et cetera, drained all of the savings. The daughter had to sell part of the property.. She then applied for a loa~n. Because of her age and health, she was turned down. This woman had no training for a job. All she knew was farming. Her children mortgaged their property to obtain the money so she could remain on the farm. It is very obvious, where the children have already mortgaged their property to pay her tax, there will be no way they will be able to pay the tax when she dies. The land that has been in the family for three generations will never make it to the fourth. IiIcidentally, she has seven grandsons who would like to farm. Another farm will go the way of the big farmer taking over. They say all of this can be avoided by proper estate planning. This family had not one, but two, attorneys. They used the attorneys who handled all of their business matters instead of attorneys specializing in estate planning. The money they gave the attorneys was lost. Even they did not have the knowledge to write the deeds correctly. I wonder what our forefathers, who gave up so much to settle this country, would think if they could return to life and see what is hap- pening. Where will our children and grandchildren have to go to own a business of their own? It is my hope that the Congress will move rapidly. Making the es- tate tax law more equitable will encourage the existence of small fam- ily enterprises. I can think of no more fitting way to celebrate this year's Bicen- tennial than to pass estate tax legislation which will save the small and middle-class people from becoming dependent on State or Federal aid. There are still many of the old school who try to save for their retire- ment. Why take their savings away. You pay income tax, land tax, per- sonal tax, sales tax, et cetera. Can't the Government let a person griev- ing a death alone? Even then it shows an even greater lack of compas- sion by making the survivor pay within 9 months. Very few are over the shock of the death before the tax man asks them to make major decisions on their property. Revenue is very important; however, death is a very cruel time to be gathering money. It always has many other expenses-funeral, law- yer, often a lengthy hospital and doctor ~bill, disruption of the business which, if a sale is necessary, means more income tax. Very often the estate tax is the so-called straw that breaks the camel's back. Revenue could be gained by evaluating some of the c~irrent pro- grams to see if they really are doing what they were intended to do, and if tbey really are getting their true dollars worth for what they cost. If estate tax is necessary, then repeal the tax evasion laws that allow the wealthy to avoid estate taxes and get back to the original intent of the law. The revemie lost if all estate taxes, were abolished would amount to 1.6 percent of the annual Federal budget, according to the Wall Street Journal. Think how much revenue could be raised if they would abolish the "outs." PAGENO="0810" 796 At an estate planning meeting the speaker told how one millionaire, and he named him, paid no estate tax by giving half to his wife and the other half to charity. If my husband or any other middle-class man gave half to charity, the spouse might end up living off of the charity. A look at your schedule of tax reform bills shows so many that are for tax exempt status. Just giving each of them a little bit less of a tax break would more than take care of the revenue problem. I realize there are many identical or similar bills to the ones I will be quoting; however, due to work on the farm and my lack of time, I will use the bills which have been sent to me or someone has called to my attention. While I support Representative Burleson's bill, I do feel it is lack- ing in the treatment of spouses. How can the issue be settled by set- trng a monetary figure which applies to all estates. I, and those who have contacted me, feel the $200,000 figure is too low. According to the Farm Real Estate Developments, Economic Re- search Service, farmland in Nebraska moved from an average of $21 per acre in 1942 to $215 per acre in 1975. This is an increase of 1,023.8 percent. If the specific exemption had been raised by the same per- centage, the $60,000 would now be $614,285. Good farmland usually sells for about $1,000 an acre. This makes the $60,000 exemption even worse. Mr. B1JRLESON. Ms. Royal, at the risk of being rude, will you forgive me and give us the time to go vote. We will be right back, and I hope it does not disturb your continuity. Ms. ROYAL. No, it won't. I understand what your job is. Mr. BURLESON. Thank you very much. We will be right back. Ms. ROYAL. All right. Mr. STEIGER. Rarely has a minority member moved up so fast, but in the interests of time, and since all of you have been so extraordi- narily patient let us proceed. Ms. Royal, I am sorry for the interrup- tion. I hope you will understand occasionally we have that happen to us, but please continue. Ms. ROYAL. Well, I understand and I respect the fact that what you are actually here for is to get to vote. We don't want you sitting down here when the estate tax comes up for a vote, I will tell you that. I am not sure where I left off, so do you mind, were I to repeat a paragraph or two? All right, I think I should repeat that if the specific exemption had been the same percentage, the $60,000 would now have to be $614,285. Good farmland usually sells for about $1,000 an acre instead of this $215 that is the average for Nebraska. The Wall Street Journal editorial on March 10 states: The fact is that inflation and the rise in real incomes now means that 11 per- cent of estates are now subject to the estate tax against one percent prior to the 1940's. Even some retired elderly people who have never earned more than $4,000 or $5,000 a year during their lives have estates worth in excess of $60,000. I hope the House will consider the ideas presented in Senator Pear- son's S. 2879, as he includes all family enterprises as long as they are managed by the heir. He has included a clause which authorizes auto- matic increases to reflect cost-of-living raises. This is very important and should be included in legislation so we will never again be caught PAGENO="0811" 797 with an outdated bill. He also has a retroactive clause which should be considered. Since this change is so long overdue, some consideration should be given to correcting the injustices which have already been done. I have already mentioned the spouses contribution clause. At the present time we feel that S. 2879 is the best bill that has been brought to our attention. Senator Bayh has introduced S. 227 in an effort "to save the family farm." While this bill sounds like help for the family farm, there is one word which will, not let it apply to many Jona fide cases; that is, "live" on the farm. I will be happy to cite examples if your time permits later. The widow may be afraid to stay on the farm and prefer a house in town, but would still manage to help on the farm. Other instances are the son may move to a farm which is more specialized and better eq~uipped; such as (confinement feeding versus grain farming, and while he may want to grain-farm the home place, he may not want to return to the father's farm to live. If there is only one house on the farm, the heir may elect to live nearby and have a hired man live in the farm home. All who have contacted me do not feel President Ford's first pro- posal solves the problem. `The estate still pays. His second proposal, a step in the right direction, is still not realistic with inflation. I thank you for your interest in this very important problem, and ask that the commitee take action without very much delay. Thank you. [The following additional material was submitted for the record:] SARPY COUNTY BOARD OP CoMMlssloxmts, Fapill4o'a, Nebr., February 4, 1976. The Sarpy County Board of Oommlssioners hereby goes on record in whole- hearted support of revl~ion of existing estate tax laws. We feel that existing estate tax laws, both State and Federal are destroying the family farm and the family owned small business. The present laws are antiquated because the exemption values are those which were set many decades ago, prior to the inflation which we have known in the past thirty years. We realize that families can give away part of their property prior to death and that family trusts can be set up. These are tools of the wealthy. The small farm and small business cannot give away any portion of their property and continue to operate. They, need the operating capital. We further do not feel that families should be forced to the legal subterfuge of a trust in order to preserve their method of making a living. Family farms and small business are an endangered species on the American scene. We feel that the present estate `tax exemption of $60,000.00 is not in line with todays inflation. This figure was established in 1942 when this was a sizeable amount as related to the value of the home, the business, the farm and to other family savings, with which average families hope to provide for themselves in later years. At that time the $60,000.00 exemption meant that only the wealthy were touched by estate taxes. We further feel that present estate `tax laws do not recognize the contribution that the wife has made in the acquisition of property held in joint ownership and joint tenancy. This should be recognized as inherent In the basic relationship of husband and wife. Anyone who i's familiar with the `farm or small business knows that the wife's labor has in many Instances meant the survival of the farm busi- ness, yet our Federal Tax laws do not recognize this. She still has to pay the "Widow's Tax" or prove monetary contribution. We feel that this downgrades the valuable contribution made by American womanhood and that it Is morally wrong. By Direction of The Sarpy County Board of Commissioners. W. V. BROOKS, (Tha'irman. PAGENO="0812" 798 Loni, CALIF., March 8, 1976. DEAR Mns. RoYAL: The enclosed information concerns our 200 acre ranch, consisting 125 acres of Wine grapes and balance in pasture for caittle. In `1937 my husband bought the ranch for $37,000.00. I will give a relative rundown over the years. I have no record from 1938-4940, but I'm sure they were in the minus income column. Income Expenses Profit or loss 1941 1942 1943 1944 1945 1946 1947 1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 $11,317 18,510 69,515 64,253 38,502 67,185 10,994 16,639 12,022 25,035 23,953 16,390 17,532 22,764 29,689 43,273 29,264 37,834 40,566 43,305 41,139 57,113 49,329 52,950 58,081 56,715 63,986 68,835 82,570 73,982 92,595 137,509 192120 145,461 $11,715 20,204 37,233 38,940 41,910 50,333 33,113 23,588 17,748 23,036 23,711 23,099 18,985 19,234 23,363 25,968 25,181 27,654 27,538 30,675 28,051 32,227 35,122 36,300 39,601 35,183 40,046 42,951 43,226 53,337 61,283 59,998 74,520 86,980 -398 -1,694 +32, 282 +25, 313 -3,408 +16,852 -22,119 -6,949 -5,726 +1,999 +242 -6,709 -1,453 +3,530 +6, 326 +17,305 +4,083 +10, 180 +13,028 +12,630 +13,088 +24, 886 +14,207 +16, 650 +18,480 +21, 532 +23,940 +25, 884 +39, 344 +20,645 +31,312 +77, 511 +117,600 +58, 481 I must add, the above income balance is before Federal and State Income Taxes. In 1974, we had enough money in the bank to cover one years expenses If we had a crop failure apd for farm equipment replacement. Then my husband passed away in March 1974. In one years time this is what I was required to come up with or else. Amount 1973 income tax $59, 000 1974 estate tax and relative expenses 60, 000 1974 ranch expenses 843, 000 1974 income tax 18,500 My lawyer managed to get me the 4%, 10 year Estate Payment Plan but as of July 1974 the Government raised that to 9%. So they accomplished their end. I paid up. I sold the herd of cattle December 1974 when the price was very low. I sold a rental house, my husbands boat, motor, travel trailer and anything else not related to the farm. I did not have the protection of a crop failure and prayed the equipment would hold up as it is old. I'm back on my feet but only because my husband and I throughout the years were hard working and never really squandered the money. I guess what I'm trying to say is, if my husband had passed away in 1971, I probably would have had to sell the ranch as the appraised value was almost as high as the $357,660 that was set for the estate. As an after-thought. Some Agriculture statistician would consider the above figures and say "There's a $17,000 yearly average before Federal and State taxes, what's wrong with that?" Well plunge one foot in ice cold water and the other In very `hot water, average that out and Ones supposed to feel comfortable. Its when that Estate Tax hits. Sincerely, Lois NIPKAU. PAGENO="0813" 799 MARCH 9, 1976. DEAR Mas. ROYAL: The Scottsbluff Star-Herald carried an article today about you and your great efforts towards reform in the inheritance tax laws. You have my deep admiration for your spirit and endeavor and I'd like to offer my support in any way it could be used. I am not offering without a great deal of feeling and determination. Everyone must feel their own situation is unique, but not too many have been placed in such double jeopardy as my mother. Last May my father and I flew her to Denver from their farm in South Dakota for open heart surgery following a heart attack. We got her lined up for surgery and my father flew back home to check on the cattle, etc. and I flew back here to help with branding, both of us planning to return in two days for her surgery. My father passed away that night on his 70th birthday and she had to go through the surgery with his grief. In a couple of months when she was well enough, we went to their attorney for the news. They had a will, everything going to my mother with her named to execute it. The only difference I see this makes it that with a will, the Federal Government gets the biggest cut and without, the state takes their's first. I believe the laws in S.D. and N~b. are similar and do give the wife a bit more of a break. The estate was evaluated at close to a half million so you can make a good guess what the verdict was, with not one dollar owed against it. Had my mother been in good health and younger, perhaps she could have dealt with it better but when they loaded up the cattle for the dispersion sale a month ago, she suffered another heart attack that afternoon. These last few weeks, I've been with her most of the time and when she signed her first installment check to Uncle Sam from her hospital bed, I truly wanted to take the Gov't. on single- handed. The machinery was sold at auction a week ago and at this writing, I'm not sure if she has a qualified buyer for the land yet. It about kills me, seeing everything my Dad worked for going on the block. My only brother died, leavi~ng 4 children and I was also widowed with 3 small boys but I guess "luckily", we hadn't accumulated anything at that time to lose! It's no wonder she had the attack, she was so upset at that point, worrying about coming up with that kind of money. A penalty for being a women, a surviving widow that the government says was only doing her "wifely duty" when she was out in the field driving a tractor and milking cows to help keep the farm during the leaner years. Perhaps you will write me and tell me just how to help in this end of the state. I am "fired and ready to work for the cause" but don't quite know how to get started. Phank~you for all your work in behalf of all farm wives to relieve them (and us) from this unjust burden. Sincerely, Mrs. ELwooD (DoRIs) WEITZEL. CORNWALL, CONN., Decem~ber 4, 1975. Mrs. LLOYD ROYAL, ~pringfleld, Nebr. DEAR Mns. ROYAL: Enclosed are signed Petitions that I have to date: My wife and I are in full accord with this movement, as we have experienced the bitter bite that the IRS imposes on an Estate under the present laws. My wife is a beneficiary under a will that caused her and her 5 sisters to mortgage the property heavily in order to pay Estate Thxes. and the only persons getting money from this Estate are attorneys and the Gov't with no chance if ever to see any benefits til 1984. If the law had been changed to the present "Bills" under consideration they would have had something. Our 0th District Representative to U.S. is Toby Moffett. Our Senators are Abraham Ribicoff and Lowell P. Weicker are three people we will write letters to. Good Luck, ALF1uDI F. PALLOKAT, West Uorn~wall, Uonn. BROKEN Bow, NEmm., October 30, 1~75. Mrs. LLOYD ROYAL, ~pringflekZ, Nebr. DEAR MRs. RoYAl.: I am herewith sending you 1,504 signatures on petitions that we `have `been `circulating in `Custer County and also adjacent counties. PAGENO="0814" 800 I am so happy that you got this matter started as I have known for the past several years that somothing should be done. I was a law secretary from 1924 to 1~58 and then I went to work again after my husband passed away I went to work for my first employer in 1972 and worked until October 1974 when he passed away I made my 50 year circle I never realized how things had changed from 1958 under 1972 in the proba tion of estates and it was really bothering me because of what some of those dear widows faced. As soon as I saw the article in the Farm Journal I ordered the petitions Imme diately my friends and I went to work and in the past two weeks it really has been rolling and especially up an our ranch country In enclose an article from the World Heard that I had published in the "Public Pulse in case that you or your friends did not see it I will have some more petitions coming in, but thought I should get these on their way Thanking you very kindly I am Sincerely Mrs C W BUCKNER BROKEN Bow NEBR March 3 1976 Mns LLOYD ROYAL S~prangflekZ Nebr DEAR Mns ROYAL I received your letter of March 1st 1976 and am only too happy to let you use my letter of October 30 1975 and if you wish you can also use this letter as I am going Into detail on two `or three estates that my last em- ployer, Attorney M. M. Runyan, administered while I was helping him close out his law business. One estate consisting of real estate, cattle and machinery owned by a mother ana divided among her children and grandchildren was valued at approximately $150,000.00. One son, an invalid in a wheel chair, inherited a portion of the real estate and a portion of the personal property and his proportionate share of the Federal Estate tax was approximately $900000 Because of this man s illness his son and wife are living on this farm with his father and mother and continuing with the farming operations When the mother passed away there was a mortgage on the farm which of course is an obligation of the son Not only that, they also had a mortgage on their cattle, and to meet the obliga- tion of the Federal Estate tax they had to make an additional loan, putting them in a precarious position. As a matter of fact, I question they can make it, if things keep on like they are. In another estate the tax came to $64,000.00 and although they had real estate, `they had no cash on hand, to speak of, so they had to mortgage the land, which was clear and today the mother is working by the day to keep her- self going and the children are trying to farm and pay off this indebtedness which was wished on them by this exorbitant taxation I think I would be safe in saying that this land that they own did not cost what the Federal ~ Estate tax came to. In an article in the Omaha World Herald I read the administration stated that increasing the exemption would cost the government $2 billion a year but in another article I read "Israel would receive $2.2 billion." Why should for- eign countries get all this consideration and not the ones paying taxes and putting food on our table? This does not sound like "common sense." Now that I have covered two estates as to Federal Estate tax in the office and results of the same, I am going to give the experience that my family and myself have gone through and still are. My mother passed away in August, 1974, and at the start of the probation of her estate it was valued at approximately $138,000.00. Later on, a farm that she had deeded to my sister, subject to a life estate in 1964 was brought to the attention of the estate attorney so he checked into the law and decided it was necessary to include the land in the estate Prior to including the land the IRS office figured the amount to be approxi mately $900000 and when the land was included it raised it to $2571340 Not only that, the attorney was dilatory in compiling and filing the Federal Estate tax return, and the estate was fined $4,569.74. Knowing what steps to take, I called it to the attention of the Nebraska Bar Association, whereupon the attorney agreed to pay same. In connection with this estate, I received $11,500.00 in government bonds and since November 14, 1975, I have been corresponding with the Treasury PAGENO="0815" 801 Department at Parkersburg, W. Va. with regard to interest due me and in the meantime they have been sending checks from time to time ranging in the sum of $30.00 up to $180.00 although the interest payments do not con- form with the due dates on the bonds. At this time the government owes me interest in the sum of $300.00 and that is not including a bond this month. It is too bad the farmer and rancher cannot strike like other people, and really let the other half of the world know how important they really are to ~ur well being. I have seen the ti~ne, and still do, where the farmer and rancher and his son, or sons, would work together and upon the father's death the sons would carry on, but if this \exorbitant taxation keeps on that will be an impossibility. I only hope that we can get our representatives to see our way of living, and keep it that way, as that is what has made our country so wonderful to live in. I say this in all sincerity. Sincerely, * LouIsE I3UCKNEB (Mrs. C. W. Buckner). P.S.-Grand Finale: "If Patrick Henry thought his tax was bad, he should see ft with representation. How about it?" YODER, COLO., March 5, 1976. DEAR MRS. LLOYD ROYAL: Good luck on your trip to D.C. I hope this letter might help you in some small way. Use any part of it. My Dad passed away in 1974 with a sudden heart attack while visiting friends. Since there was a doctor's office just across the street it was no time before he had medical help but "he was dead before be reached floor," so the doctor said. My mother has paid almost $50,000 for State, Federal and lawyer fees since. Thank God she had money to pay it with. Many are not that fortunate. How- ever she has been in a wheel chair six years now and can only feed herself, and that is becoming a task. Due to arthritis everything else must be done for her, getting dressed, comb her hair, bath, taken to bathroom, moved from one chair to another, etc. Thank God for two loving daughters-in-law and two sons-in- law to take care of her. She spends a week with each of us four kids, each month. Since the government has seen fit to take so much tax from her what else can she do. Nursing homes are completely out of reach for elderly people on small incomes. Three of us live on her land and a sister near us, owes her a large sum of money for their land. All of us worked very hard before and during our teen years while home. My dad believed if you didn't work them young you would get nothing out of kids. We farmed 2000 acres and never shut two tractors off. One brother and I ran day time and a brother and Dad ran nights. We ran several hundred head of cattle and it was my job in the winter to bring them to the corral on horseback each night or sometimes herd them In fields. It can get cold on a horse. It was nothing for my mother to have six to nine men to cook for, plus we six during harvest. Yet she always came out after dinner and worked until sun down. She would then hurry home to feed the pigs and chickens, milk the cow and do other chores and still have supper on the table when we all got in after dark. We had no electricity, refrigerators or even water in the house at this time so all meals were made from scratch. Yet we had to have seven or eight people sign a statement that she helped make her half of the estate. Anyone knows a farm and ranch wife has worked beside her husband in all kinds of weather. Just yesterday we received six inches of snow and I was out helping my husband feed cattle. We bad to bring a new born calf and mother to the barn and this morning I have a half frozen one in my porch, hoping to save it. As cheap as they are I wonder why sometimes. How many urban wives would allow a calf to mess up her lovely home? I ask you is it right for a woman who has worked so hard and now in a wheel chair and unable to care for herself to be taxed penniless? Sincerely, MRs. HARRY GRIST. PAGENO="0816" 802 KNOB NO5TER, Mo., March 7, 1976. Mae. LLOYD ROYAL, $pringfleld, Nebr. DEAR Mas. ROYAL: In reply to your letter of March 1, I have written five letters and made four longdistance telephone calls as of March 4 to urge persons to write to you and their Congressmen and ask their friends to do likewise. Those that I know of personally are: One old couple who have both died since she told me about it. They lived more or less frugally and were very. thrifty. They lived the way they were brought up and wasted nothing. She had two brothers who were single when they died. She said it cost them $35,000.00 to settle her brothers' estates. That was several years ago. Now due to inflation it would have been much more. I doubt if this couple left much of an estate as they were forced to live in a nursing home for several years besides being hospitalized for some time. Another histance: The family had a large `farm and quite a bit of live- stock. I think perhaps part of the farm had i~een inherited. The father died and before his tesate could be settled, just a matter of a few months, the mother was killed in a car accident. I have been unable t~o find out exactly, but their tax was at least $40,000.00. This was either 1974 o~r~ 1975. I have not asked them to write as I feel they would not anyway, for a spe~ciflc reason. A friend of mine was to close the settlement of her husband's estate just a few days after we started the petitions here. I asked her if her accountant had said anything about what she had inherited and about her working for years and putting her earnings into the joint bank account and spending it for feed, etc., and buying more land. She said, "no." So I told her to tell him which she did and she says she still had to pay but that he reduced it, but she has not heard yet whether it will be acceptable to the IRS. My father died in October 1970. It just so happened that his estate was only about $120,000. He was 82 and had a car accident. My mother is now 89. We have reduced her estate to a little over $60,000 which will be reduced more as she is in anursing home, but she will have to live more than two more years, to keep us from paying the tax on her estate unless the new exemptions become effective. Our banker cited an instance where the final estate of the wife (the hus- band had died previously) was taxed, Federal Estate Tax only, $155,000 and this couple did not even have a bathroom in their house. This also was a few years ago. The way our estate is now, there would be no way for us to begin to pay the Federal Estate Tax. We have business that is not of a type that could be read- ily sold and certainly not within a year. We do not have other assets that could be turned into cash for enough to pay the Federal Estate Tax. There would just be no way to do it. If only 2% of the Federal Taxes come from Federal Estate Tax as I heard the other day, then who is paying it? Not the rich and certainly not the poor. No, just those of us in the middle. It seems to me that this tax is not only unfair but is also discriminatory. Also, there are those in this area that are afraid that the bills will not be passed as someone will say they are discriminating if they only mention farmers and small businessmen. We want the exemptions changed for everyone. If it were not for inflation, it would not be necessary. In 1942 when $60,000 was the exemption, it would have been adequate. At that time $10,000 was a lot of money as far as we were concerned. Even that amount seemed to be beyond our attainment. Now we urge the enactment of new exemptions; namely, the specific exemp- tion to at least $200,000' and the marital deduction of 50% plus $100,000. We also believe that farm land should be yalued at its present use value and not for some potential value such as development for housing or industry or the potential growth of forests that are still in the sapling state. We heard of a lady in a western state whose ranch was valued at the rate of the value of the timber at harvestable size instead of the small trees as they are now. It became a very sizable estate and would have left her with less than one- fourth of the appraised value. If those trees would burn off, she would have nothing. If this is true, it is unbelievable. It is our understanding that she is resorting to legal action to try to protect herself from this tax. Thank you for writing to the Farm Journal. We would not have known what to do if it hadn't been for those articles. We hope we have helped in some PAGENO="0817" 803 small way. We have semt 6,~i0 signatures to Rep. Uliman and probably sev- eral thousand more were sent direct to him by others who asked us for copies and sent them in themselves. Many had copies made from our copies and sent them in. [f there is anything in this letter that you can use, you have our permission to do so. Sincerely yours, MR. AND MRS. E. 0. PRIcE. FEBRUARY 25, 1976. Mr. JoHN M. MARTIN, JR., Chief Counsel, Comm/ittee on Ways and Meanr, U~$. House of Representatives, 1102 Longworth House Oj7tce Building, Washington, D.C. DEAR MR. MARTIN: My daughter and I are the sole heirs to a farm in Wood- ford County, Illinois near Eureka. My husband died on July 14, leaving us a heritage, but we are trapped with a farm assessed at $~00,000.00, far out of proportion to its producing revenue, particularly since we must share the revenue accrued with an Illinois farmer, a cousin who farms it for us. There seems no way to reduce this assessment in the settlement of my husband's estate. In order to keep this farm, we must liquidate a sizable amount `of our `other interests, thereby reducing our living expenses. Our tax including this farm would be around $100,000.00. My husband inherited this farm from his parents, who in turn inherited it from their parents, who broke the prairie in Illinois. I wish to keep it in the family for my `daughter, but the estate tax on farms is prohibitive. We could sell the farm at existsing inflated prices to prospectors, but we wish to keep it to be farmed by a cousin, whose two sons recently returned from the armed services, and who desire to farm with their father. Has the House of Repre- sentatives heard of the effort, "To keep the boys on the Farm"? Such a law was written back in 1942, when farms were valued at some $60,000.00. Surely it is not applicable today. I am glad that our U.S. Congress sees the injustice of this tax, and is willing to do something about it. I hope that in considering the nature of the tax bill, that you will take into consideration the factor the time element. My husband died on July 14 of 1975, but I have not settled his estate as yet. Ac- cording to the law, the time for settling his estate expires in April. Is it possible that this tax matter will be settled before that time, and I may be able to profit by the change? I am asking for an extension of time for the settlement. What about the many who have had to pay this unjust tax in the past with result in losing their farms to succeeding generations? We are celebrating a bicentennial of a war fought primarily because of unjust taxation. This is not a cry in the wilderness, but a voice speaking from the productive prairie land of central Illinois. Please help. Very sincerely yours, MRS. JOHN D. KYSER. QUOTES FROM LETTERS REcEIvED EY MRS. LLOYD ROYAL ON ESTATE TAXATION With the appreciation of land values, farmers can be poor rich people in a hurry. (725 Ohio) Some of my points are: 1. When property is owned jointly-yet a wife must pay inheritance tax on both halves, she is denied the right to own property. 2. Taxes are paid by joint return therefore she has already paid the tax on her half of income-how can she inherit what is already hers? 3. If labor is not a con- tribution then her husband's labor should not count either. If his does, then this constitutes slavery. Slavery was abolished in 1865, therefore the law is illegal. (U-i Wis.) A lady from Kansas: With credit laws and all of the discrimination of varying sorts against women in general, my mother and I have spent the better part of her lifetime and mine trying to save up what we could to pay a goodly inheritance tax in all probability on my mother's agricultural land to me. We have dealt with inflation, droughts and a general increase in all overhead for numer- ous years. (Ks.) Our local agent tells us that if we were left with this problem I would have to sell everything to pay the taxes, after a lifetime of hard work and struggle and we aren't wealthy now, either. (#F N.Y.) PAGENO="0818" 804 I began circulating your petitions and did not become totally involved until a friend of mine told me that when they incorporated their business she had to pay a GIFT TAX on the shares that she was to hold on the corporation because she could not give monetary proof of her contribution in building the business. WOW!! (#EWis.) My husband and I are in our seventies; we have worked (I without a dollar's pay) for 46 years to get our ranch paid for and improved and now we are faced with the unfair widow's tax. I am not a womefi's lib but I certainly would like to join the protest, against this situation. (#E-1 Tex.) We are now in the same category as a tractor or other piece of machinery. Slavery is legal in Ws. in 1976. (#T Ws.) No other segment of our economy faces the risks that farmers do yet we also have that perpetual faith and hope always for a better year. (#U Cal.) My own State, South Carolina, has similar legal requirements and it seems almost impossible to get our General Assembly to change without Federal Change-therefore we have a double dose. (#0 S.C.) The average farmer's wife who works outside the home to make the operating capital for the farm, spends another eight (8) hours' work each day at home- is there no law to pay her any return for all this work. (# C Tenn.) There is no use for us farmers to get better prices for our production, if in the end the government in effect confiscates much of our land and savings. (#M S.D.) The country cannot be stronger than the families that make it up. When home- making is not considered of importance to the family, and the laws certainly show this, women are forced, even if they know better about its importance, to look on it as something they must get away from. (#J Ill.) Not only does your problem exist in the farming areas of this State (believe it or not, agriculture is our second largest industry) but estate taxes on middle in- come families presents as great a hardship in my New York City district, especially on the homemaker wife and the wife in the Mom-and-Pop stores and small businesses. We have passed legislation to assist in the real estate taxes for farms but none for estate taxes. ~ #K N.Y.) The market value of our farm land is outrageous. We are trying to save 400 acres for our son, but his taxes will be out of sight. (L386-4Minn.) Why should any farmer at death leave to his wife a "drummed up" estate tax and slap it at her with 9 mos. time limit. Just such is going on in the dif- ferent states I have convassed and these widows now on welfare, are living examples of the heavy land of the law where tyranny has taken over & taxation without representation has become a lost cause-every deceased husband died thinking he was leaving his wife a home and a shelter, a roof over her head & a means to make an honorable living. (#P Ks.) The $60,000 exemption is pitifully low and should be raised to a $200,000 minimum. Too many of our farms in New Jersey have to be sold when the owner dies in order to pay inheritance taxes on today's inflated values. As you can see, $60,000 is ridiculous. (#R N.J.) My husband and I made out a will recently and the inheritance tax would be a terrific amount of money. He and I have worked very hard ever since we were married 30 yrs. ago to have money to buy some land where we could live and call "our own", now it seems like the government wants to "slap our hands for doing it by making us pay such exorbitant estate taxes. We would like very much to pass the farm on to our children who also worked very hard with us to save hiring someone but we won't be able to if we have to sell some land to pay inheritance taxes. (J-1 Ks.) My husband has been a farmer (apricot, and prune grower) since he was 15 years old. He is now 70, and in between he has "eaten" his share of good clean "healthy dirt"; so we feel the same about the eventuality of his beloved orchard having to be sold to satisfy such an unfair tax structure. (K-i Cal.) I was very upset to realize that the average 14 hr. day I put in for our farm labor means nothing. (B-i Ohio) In our area this has been caused not just by the pressure of population growth, but was started 20 or more years ago by municipalities taxing the owners of open land as though it was already sub-divided. The result has been to force al- most every farmer in our area to sell to development whether he wanted to or not. (#XN.J.) We have wondered many times about what would happen to me or my husband should the other one pass away. The estate tax would completely put us out of business. We have a small grain farm and about 80 head of cattle. (A-i Tex.) PAGENO="0819" 805 My wife and I own 480 acres of land that we live on, that's what we accumu- lated by scratch, and we are in our sunset years, and the way it is with rising land prices, our children would have to mortgage their homes to save our estate, with the $60,000 exemption. (#L Wn.) A New Jersey gentleman writes: At the present I am working on an estate * settlement, and all I can say is that between the State of New Jersey and the Federal IRS the whole thing is "unreal." (N.J.) From a Calif. gentleman: Our orchard land has been in the family for over 100 yrs, and now because of this unfair tax in an inflationary period the resources of the family (never more than provided a living for the family during the past 30 yrn) is now about to be confiscated by the government for taxes. (Cal.) I have worked fourteen hours a day six days a week for the past thirty years raising four children-sewing, cooking, baking, gardening, canning, freezing, etc., and certainly feel that I have made a contribution to what we have accumulated, and that this contribution should be recognized. (#L 403 Tenn.) The farm wife is the most intense example of a business partner there is farm wives who tend cattle, run the tractor, throw bales, sell crops and buy machinery, etc.,.. . I shouldn't have to be in poverty when he dies (# Q Tenn.) We live on a 130-acre farm in Indiana which we bought 12 years ago for $30,000. It had an old rundown brick house (about 80 yrs. old), after we improved it the insurance co. would insure it for $5,000. The 2 barns were in bad shape; the land run down-it has taken all our money and we've both worked hard to improve it, if my husband were to die today the IRS would come out and value our property to probably $130,000 or more since land has tripled in the past 8 years. I would have to sell the farm, cattle and everything just to pay the taxes. Where would it leave me and my daughters? Out in an apartment, just getting by (S-iInd.) My husband passed away July 18, 1974 and the estate isn't settled yet. In 1946 my father~in-law died and we bought the farm for $9,000. In 1974 when my husband died the same acreage was appraised at $131,000, but the exemption is still the same $60,000, so I paid a lot of taxes. What a rip-off! My husband was ailing since 1965 and the boys and I run the farm and I have helped on the farm since 1931, when we were married. (P-i Wis.) NOTE: This petition, known as the Royal petition, addresses the specific issue of estate tax discrimination against wives. Since it is a public opinion peti- tion, it is proper to add signature pages, as long as they are securely attached. Also, addiitnoal copies of the petition itself may be made on a good grade copy machine. Most people will want to put their names on both the Royal and the Brooks petitions. Mrs. ROYAL. To: The Honorable (Senate) (House) Office Building, Washington, D.C. We, the undersigned are concerned citizens of the United States and the State of , and are particularly concerned with that portion of the laws of the United States and the State of , relaitve to the taxation of estates which provides that the full value of property which a decedent held at the time of his death, either as a joint tenant or a tenant by the entirety is includable in his estate, unless the surviving tenant can show contribution toward the purchase of the property. The undersigned strongly believe that the foregoing provision of federal and state law unjustly discriminates against women who work in the home, on the farm or in a family business and make a contribution toward the acquisition of property held in joint tenancy or tenancy by the entirety with right of survivor- ship with their husbands. Even if both spouses contribute significant physical efforts to earnitigs over the years and such earnings are the basis for increase in estate, at the time of death, the entire estate is considered to have been earned by the husband. Justice and fairness dictate that this palpable inequity and inconsistency be corrected. There is no logical reason why women who make a contribution by working other than for salaries should be discriminated against. The undersigned petitioners earnestly hrge that federal and state law be amended and changed to recognize the contribution of women who work in the home, on the farm or in a family business toward the purchase and acquisition of property. PAGENO="0820" 806 We respectfully request that you introduce and work diligently for legislation which will allow women to show contribution for work performed which con- tributes to the acquisition of such property for purposes of federal estate and state inheritance taxes. Respectfully submitted, Name: Address: NOTE: This petiiton, known as the Brooks petition, addresses the issue of cor- recting the various inequities in present estate tax laws. Since it is a public opinion ppetition, it is proper to add signature pages, as long as they are securely attached. Also, additional copies of the petition itself may be made on a good grade copy machine. Most people will want to put their names on both the Royal and Brooks petitions.-Mrs. Royal To: We, the undersigned, are citizens of the United States and the State of who are particularly interested in reform and modernization of the Federal Estate Tax laws. We believe that Congress should correct the inequities in present estate tax laws and should give recognition to the effects of inflation upon these laws. The present $60,000 exemption was written into law in 1942. Currently a widow has to pay such high inheritance tax on her husband's estate (even if the prop- erty is in both of their names) that she may find, herself virtually destitute. We believe that existing law creates a severe hardship upon taxpayers and penalizes those citizens who have accumulated property through hard work and the exercise of frugality. Accordingly, we urge the Congress to enact into law 5. 1173 now pending in the Senate and H.R. 1793 now pending in the House which would increase the specific exempiton to $200,000.00 and increase the marital deduction.'by $100,000.00. Respectfully submitted, Name: Address: Mr. STErnER. Mrs. Royal, thaiik you very much. Mrs. Smith, when she testified today, made mention of the work that you have done. It is very obvious that this is something to which you have committed a substantial amount of time and effort. Ms. ROYAL. It is still very unbelievable that me getting my dander up one blizzard day could reach 48 States, and incidentally, we re- ceived the 49th one since I left. We only have one to go and then some- one from all 50 States will have contacted me to help. Mr. STErnER. Thank you. Do your colleagues have anything to add at this point to what has been said? Ms. ROYAL. These other two ladies have statements. They just al- lotted me part of their time. The gentlemen were here for the questions, if you asked me something that I could not answer. Mr. S1~IoER. All right. Ms. ROYAL. Thank you. Mr. STEIGER. Our next witness is Helen Rafert from Gresham, Nebr. STATEMENT OP HELEN RAPERT, GRESHAM, NEBR. Ms. RAFERT. Thank you, Mr. Chairman. Mr. Chairman, and members of the committee, I appreciate this opportunity to give my views. For the record, I am Helen Rafert of Gresham, Nebr., York County, Nebr. I am a farmer and a homemaker. I have three sons that are farmers. We grow corn, wheat, beans, milo, and livestock. I assist my PAGENO="0821" 807 husband and sons with farming whenever needed. I can operate any of the machinery, except the big combine. That I let alone. I also have 1,750 signatures to be added to Doris Royal's petitions making a grand total of 131,801, and they are still coming in. My grandfather homesteaded ~I1 Nebraska in 1870. We are the fourth generation of farmers. My toughest work right now is keeping up with the markets, and how to get the farming done right without wasting time and money. Our Federal estate tax is very unfair and far out of date. It is com- pletely out of line with today's inflated prices of land, farm equipment, and operating costs. If our Federal estate tax exemption would have increased as much as wages, the Federal estate tax exemption would have raised an average of 12 percent each year since 1942. There is no way a young farmer can start up farming, unless he inherits the farm. The impact of estate taxes at the present inflated prices could be dangerous to the point that young farmers may realize there is no future in farming. These young farm boys get into the action and training early in life and by the time they are 18 years old become very good farmers. Farmers Mire the largest capital investment with the smallest return. They have the grain drying, grain storage. buildings, along with tractors, trucks, combines, planters, fertilizer and weed control machines, and all irrigation equipment, plus operating costs such as gas, oil diesel fuels, repairs, chemicals, fertilizers, taxes, and insurance. Farm equipment could cost one-third the price of the land, and many times it is a part of an estate. Nonfarmers and investors buy farmland even at inflated prices, making it almost prohibitive for a farmer to expand. It is very impor- tant that farmers own and control their farms, to be efficient, get the most production per acre, keep expenses and taxes to a minimum, to produce food at the lowest possible cost to the consumer for the same investment. We all pay taxes on money before any property is paid for, and when that property falls into an estate, it should not be taxed again. There is no incentive to work hard and accumulate property and have taxes take it away. I am in favor of replacing the Federal estate tax money from the foreign aid money. Through manipulation, many never pay estate taxes, therefore the Government doesn't receive any tax. To eliminate the estate tax would sure help our economy, and it would also tnake farming more attrac- tive to the young farmer, especially if he has to buy out other members in an estate plus equipment. And that young farmer sure does not need Federal estate taxes to burden him. If we must have a tax, let's get a substantial increase in our exemp- tion, in line with our inflated prices and give husband and wife as joint owners, equal rights of inheritance. The farmers best interests are for all America. We need each other, must work together, and if we don't succeed the whole world is a loser. We ëarry the food basket. I thank you. - [The prepared statement follows:] 68-872 0 - 76 - 53 PAGENO="0822" 808 STATEMENT OF HELEN RAFERT, GRESHAM, NEBE. NEED FEDERAL ESTATE TAX RELIEF I am Helen Rafert of Gresham, Nebraska, York County, Nebraska. I am a farmer and a home maker, have three sons that are farmers. We grow corn, wheat, beans, milo and livestock. I assist my husband and sons with farming whenever needed. My toughest work right now is keeping up with the markets, and how to get the farming done right withont wasting time and money. Our Fed~ra1 Estate Tax is far out of date. It is completely out of line with today's inflated prices of land, farm equipment and operating costs. There is no way a young farmer can start up farming, unless he inherits the farm. The impact of estate taxes at the present inflated prices could be dangerous to the point that young farmers may realize there is no future in farming. Farmers have the largest capital investment with the smallest return. The grain drying, grain storage buildings, along with tractors, trucks, combines, planters, fertilizer and weed control machines, and all irrigation equipment, plus operating costs such as gas, oil, diesel fuels, repairs, `chemicals, fertilizers, taxes, and insurance add up to a terrific investment. Non-farmers and investors buy farm land even at inflated prices, `making it almost prohibitive for a farmer to expand. It is important that farmers own and control their farms, to be efficient, get the most production per acre, keep expenses' and taxes to a minimum, to produce food at the lowest possible cost to the consumer for the same investment. We all pay taxes on money before any property is paid for, and when that property falls into an estate, it should not be taxed again. There is no incentive to work hard and accumulate property and have taxes take it away. Through manipulation, many never pay estate taxes, therefore the government doesn't receive any tax. To eliminate the estate tax would sure help our economy, make farming more attractive to the young farmer, especially if he has to buy out other members in an estate. If we must have a tax, let's get a substantial increase in our exemption, In line with our inflated prices and give husband and wife as joint owners, equal rights of inheritance. The farmers best interests are for all America. We need each other, and must work together. If we don't succeed, the whole world is a loser. We carry the food basket. Mr. BURLESON. Thank you, Mrs. Rafert, for your statement. Ms. RAFERT. You are welcome. Mr. BTJRLESON. With the consent of my colleagues on the committee, we will take this time to say, Mrs. Royal, as you mentioned the peti- tions in the boxes, Chairman Uliman is aware of the petitions and he knows the numbers. On his behalf, and I am sure the members here will join me, we will accept those petitions, and they will go in the committee's file. They will be available at the time we begin the mark up of this bill. They will be available for those members who are now absent to see. The petitions will be called to their attention. I assure you that they will be impressive. There are great numbers from 4~8 States; is that correct? Ms. ROYAL. I don't think you were here, Representation Tjllman, but after I left for Washington we now have 49. I have one more at home. Mr. BURLESON. Do we? Well, Chairman Uliman had to be away. My place is down near Centerfield. M's. ROYAL. Oh, I knew better. You will have to excuse me. This is my first time. Mr. BURLESON. Well, that is certainly all right. It is almost my first time, too. PAGENO="0823" 809 But anyway, I will repeat, that those petitions will be here at the committee, and they will be called prominently to the attention of the committee members, too. Coming up on the elevator now Mrs. Keys was saying how much she appreciated-of course she can express herself-the great effort that you put into this, and I am grateful for it, to all of you. But I am just trying to assure you that those petitions will be prominent in the committee's consideration. The next witness on the list is Mr. Bock. We will be glad to ~hear you, sir. STATEMENT OP ALAN W. BOCK, DIRECTOR, LIBERTARIAN ADVOCATE Mr. BOOK. Thank you, Mr. Chairman. I do have a prepared statement. I would appreciate if that could be put in the record, and in the interest of time I would like to sum- marize it. Mr. BURLESON. Without objection, your full statement will be in- cluded in the record, and a summary will be appreciated. Mr. BooK. OK, thank you very much. Mr. Chairman, and members of the committee, my name is Alan Bock. I am director of a new outfit called Libertarian Advocate, which has formed a lobby for what we believe is a philosophy of human indi- vidual liberty. We have heard a lot of talk this morning and this afternoon about the various inequities in the inheritance tax, and we believe that the time has come to eliminate inheritance taxes and their cousins, the gift taxes, altogether. We believe this is a cruel tax which works no positive good. It is strictly a destructive kind of a tax, and the time has come to seriously consider eliminating it. Look at the human side of the inheritance tax. It is imposed at the cruelest possible time, when somebody has died. At that time the widow or widower, family and friends, are psychologically in a most vulnerable position. There are various other problems which demand their attention, and they are striving to cope with this great loss which they have suffered. At this time when they have suffered an irreparable loss, along comes the tax man to say, "No, you haven't suffered a loss at all, you have actually made a gain, and you are going to have to pay some taxes on it." So they call their lawyer and prepare themselves for the onslaught of lawyers, investigators, investors, appraisers. People come into their homes, invade their privacy, all for one pur- pose: So that the Government gets its bite out of their estate. What real purpose can such a tax serve? The small amount of money that is collected from it, the specific exemptions, and1the high pro- gressivity of it, suggests that it is strictly a penalty for wealth. I think that it probably arises from a desire to do something about equalizing the unequal or inequitable distribution of wealth, which seems to evolve in society, but does the inheritance tax really serve that purpose? It would seem that a more progressive form of legislation or Govern- ment action would be directed at helping those at the bottom of the economic ladder to improve themselves, rather than simply trying to PAGENO="0824" 810 penalize those who have made it up to the top one way or another. The inheritance tax does not do anything to help the person who is at the bottom of the economic ladder. What it does, in fact, is to take from those that are relatively wealthy and perhaps a little power- ful and transfer funds from them to the wealthiest and most powerful institution in society, the Government, the State. I can't see how a poor person could gain any satisfaction at all from the existence of the inheritance tax. In addition, what are the economic consequences of the inheritance taxes? They reduce the proclivity to save because if the Government is going to get a bite you are going to conserve less. In addition these taxes hurt the economy in general, since saving in a market economy is the chief source of capital formation. What it does is to reduce economic activity. Another effect is in fact it reduces contributions to charitable and philanthropic organizations since people in the Govern- ment are going to take a bite. Only the very wealthy are able to make any kind of charitable and philanthropic contributions. Sometimes this is to avoid taxes, but in fact people are going to take care of their families first and if they have got anything left over they will contribute to charity. But if they know the Government is going to take a big bite, that is that much less going to charities and philanthropic organizations. But the most important effect is to increase caution, to reduce the proclivity for risk taking in money management. Here is where it is really a deleterious tax for those who are at the bottom of the economic ladder. What a poor person needs in order to improve himself is an economic environment where there is a great deal of risk taking, there is a great deal of activity. His chances for climbing up the ladder in a situation where there is a lot of activity going on are going to be that much better. But when you have a tax which reduces people's proclivity to risk taking, increases caution in management, what it does is in effect strati:fy society at the position where it is; the wealthy stay relatively wealthy and the poor stay poor and the people in the middle suffer. Other legacies of the inheritance tax are people setting up trusts to avoid taxes when the money involved could be productive. We see people going abroad in search of various exotic tax havens. The very wealthy of course can find the loopholes. You are not going to be able to close all the loopholes. In time the lawyers will find a way around them. If you have got enough money you will find a way to avoid payment of the taxes. Billions of dollars are spent each year looking for tax loopholes leading to socially unproductive use of money, and that is money that could be used to build the American economy. It is not just the mheri- tance tax, but seeking schemes to avoid inheritance taxes is one area where a great ~leal of money which could be productive is really frit- tered away, wasted as far as society at large is concerned. We have heard a great deal from this panel and others about the effect of the estate taxes on family farms and businesses, and I can't expound any more on what these ladies have said here. The other question we should consider is this: does Government really need the revenue that comes from these taxes? It amounts to about 2 percent of Federal revenues, but at the same time inheritances PAGENO="0825" 811 are not treated as income. I would think that if they were treated as income, with liberalized provisions for income averaging so that you would not get stuck with, you know, the one lu'mpsum~ over a year, but it could be stretched out, say, over 10 or 15 years, that the revenue would be more than made up. Finally, I would just like to say that inheritance taxes in effect are taxes on acts which reflect love and concern for other people. A man or a woman works hard so that he or she can leave some- thing for their family. This reflects concern for them, it reflects love for them, it generates those kinds of intangible ties between the gen- erations, which are the real foundation of a solid and stable society. And what happens is that the Government penalizes this impulse, this generous impulse of love, the generous impulse of caring about those who are important to you. Inheritances also make it possible for private wealth to be used for charitable, cultural and philanthropic endeavors. Without private wealth the only source of support for these kinds of endeavors would be the Government, and I think it would be unwise social policy to be creating a monopoly by anybody in this kind of area. If the committee isn't ready to abandon this inheritance tax alto- gether, I would suggest that you consider eliminating inheritance tax on inheritances which involve only the direct family, because in most cases an estate is not his or hers, it is ours in almost every family. And to penalize one member of the family when the other dies I think is patently unfair. Thank you very much for your kind attention. Mr. BURLESON. We thank you, Mr. Bock. It is going to be interesting when we get around to the questions. I want to get back to you. Mr. Boox. All right. Mr. BURLESON. Somehow I had not expected you to make this state- ment. Mr. BOOK. Thankyou. [The prepared statement follows:] STATEMENT OF ALAN W. BOCK, DIEECTOR, LIEERTARIAN ADVOCATE Distinguished Members of this Committee and Ladies and Gentlemen, I am Alan Bock, Director of Libertarian Advocate, an organization founded to pro~ mote individual human liberty and to make the ease for liberty In the legislature and other important forums. The time has come to eliminate the inheritance tax and its cousin the gift tax from the arsenal of weapons which the federal government has evolved to harass its citizens. The inheritance tax is a cruel tax which works only in a negative and destructive fashion, accomplishing no positive good whatsoever. It makes no contribution to social justice and the insignificant amount which it adds to the federal coffers cannot possibly be justified by the human `misery and social `damage which it causes. The best course would be to eliminate It outright. Let's look at the human side of the inheritance tax first, It is Imposed at the cruelest possible time, when somebody has died. At such a time the widow or widower, and family and friends of the deceased are struggling to cope with the loss, which always hurts no matter how long it has been anticipated. There are funeral arrangements and last-minute business and family affairs to be attended to. Everyone is at a low psychological ebb, vulnerable to exploitation. At such a time of sadness, `when a family has suffered the most irreparable of losses, along comes the tax collector to inform them that they have made a gain through inheritance, and the government is going to make them pay for this crime. They huddle with lawyers and prepare for the onslaught of appraisers PAGENO="0826" 812 and inspectors. Their homes are invaded and inspected with minute thorough- ness. The most private corners of their lives are opened to the impersonal inspec- tion of hired officials. When humanity and compassion suggest that a govern- ment might either help a family which has suffered a loss, or at least leave them alone, the government invades the bereaved family and makes their lives all the more miserable. - What possible purpose can inheritance taxes be said to serve? The limited amount of money collected through these taxes (about 2% of Federal revenues) the high specific exemptions, and the highly progressive rate schedules lead to the conclusion that their purpose is to penalize the holding of large amounts of wealth. The impulse undoubtedly derives from the feeling that something ought to be done about the unequal distribution of wealth in society. Buit the iniposi~ tion of inheritance taxes is possibly the worst possible solution. Equity and humanity would suggest that rather than taking the negative step of penalizing success, government might better direct its attention to helping those at the bottom of the economic ladder improve their situation. The inheri- tance tax not only does nothing to help the poor, but the evidence suggests that they do positive damage `to the prospects of the poor for climbing up the economic ladder. The only conceivable justification for inheritance taxes is the legitimation of envy, the act of making envy part `of the law. But even this is a poor excuse. It's easy to see how a poor person could envy people of greater wealth, but it's difficult to see how he could derive any satisfaction from the existence of inheri- tance taxes. What inheritance taxes do is to take something from the modestly wealthy and possibly powerful and use it to add to the resources of the most wealthy and powerful institution in society-the government. The poor person gains nothing tangible from such a transaction. His enjoyment must be distant and vicarious indeed, especially if he reflects a moment and understands that these seizures actually retard his chances of improving his own situation. What are the economic effects of inheritance taxation? The first and most important effect of high inheritance taxation is to reduce saving in society. Since savings are `the most significant source of capital in a market economy, the effect is to retard economic growth and investment in new I)roductioli and job creation. A second economic effect is to reduce contributions to charitable and phil- anthropic organizations. There is a myth that inheritance taxes encourage such contributions since they are deductible from the tax obligation. This is a myth which should be exploded. Persons of modest wealth will take care of their families first. WTIth inheritance tax looming over them, they know the government will take a bite. That leaves only some left over for charitable and philanthropic contributions only from large fortunes. Economic studies indicate that contri- butions from modest accumulations of wealth would `be greatly increased in the absence of inheritance taxes. The most important economic effect of high inheritance taxes Is to increase caution in money management and to reduce the propensity of risk-taking. Here is the del~terious effect on those at time lower end of the economic scale. What is most helpful to a person with little wealth who wants to improve his lot is an economic environment of heavy activity amid a willingmiess to take risks in investing. The more in-tense the economic activity and the niore willing people are to take risks, the `niore economic amid social mobility is possible. The most significant `beneficiary of a free-wheeling economy is the person at the lower end of the economic scale. When tax policies impose caution and conservatism, the chances to improve your position are reduced accordingly. With fewer risky activities undertaken, time wealthy stay wealthy amid the poor stay poor. Inheri- tance taxes contribute to that kind of stale and stagnant economic environment. The poor are `harmed rather than helped. What are the other legacies of inheritance taxes? We see people setting up trusts to -avoid taxes, keeping money locked up When it could be doing productive work in the economy. People send their `money abroad in search of exotic tax havens rather `than investing it at home -where it could make a contribution to the economic health of the United States. Billions of dollars are spent each year in tax avoidance schemes, aiid you can't hope to close the loopholes fast emiough. Those billions `are socially useless dollars, frittered away due to -the tunnel vision of `the tax men. If those billions were invested in our economy, some of it would be spent for things most -of us would consider wasteful. But now, from the standpoint of society at large, all of it is wasted. PAGENO="0827" 813 Finally, inheritance taxes lead *to serious problems with family farms and businesses. We are all familiar with cases of families `having to sell their farms in order to pay the inheritance taxes, When they would prefer to keep on farm- ing. The social consequences are devasting: loss of potential farmland, loss of open spaces, encouragement of u'rlban and suburban sprawl, and the possibility that we may in the near future destroy our national ability to produce enough food to feed our population. Closely-held and family businesses suffer likewise. Economist Clielcle Bosland did a study which indicated that in the years 1955-59 estate tax considerations played an important part in decisions by closely-held small small businesses to merge or sell out in 63% of t'he cases. Here we have a classic example of tax laws imposing artificial incentives to make businesses larger and more imper- sonal, encouraging the growth of corporate `bigness, discouraging the diversity and healthy competition which comes with a diversity of small business able to meet specialized demands. Does the government really need the revenue which is produced at the cost of all this human misery and social and economic dislocation? Inheritance and gift taxes have historically `accounted for about 2% of federal revenues. In light of this separate `taxation, inheritances are not subject to income taxa'ti~n. If inheritances and gifts were treated as income, with a liberalized provision for income averaging since it is unlikely that Congress will take the sensible step of eliminating the progressive feature of the income tax, the revenue could be made up easily, and much more equitably. The inheritance tax and its bastard cousin the gift tax are cruel `taxes in one other sense. They are taxes on acts which reflect love and concern for family and friends. A person `works to accumulate something to leave to his children because he loves them and wants to do something positive for them. Inheritances build bonds between generations of affection `and interdependence. The fact that leav- ing inheritances does not always guarantee security or happiness, or even may lead to family squabbles does not diminish this motive of love and caring. Inheritances also make i't possible for private wealth to `be used to support charitable, cultural and philanthropic endeavors, encouraging diversity and sup- port of minority persuasions in ,these areas. The elimination of private wealth would leave the government in a monopoly positiOn `with regard to such humani- tarian undertakings. Encouraging monopoly power in any area would not seem consistent `with enlightened social policy. One final suggestion. If this `Committee is not yet ready to abandon `the destruc- tive policy of inheritance taxation entirely, at least it should consider eliminating taxation on inheritance transfers made to members of an immediate family. A widow whose husband dies is not enhanced by that death. In almost every case the possessions and holdings of the family were hers previously, in fact if not In law. To take part of those joint holdings at a time when she h'as suffered .the most cruel of losses already is barbaric. `If inheritance taxes are to be preserved, let them `be reserved for transfer of property and wealth outside the family. Gentlemen, `thank you for your kind attention. Mr. BURLESON. Did I understand, Ms. Furber and Ms. Lane, do you not have some additional statements? STATEMENT OP LAURA LANE Ms. LANE. Yes; I did not expect to take the full 10 minutes. I really wanted to cede part of my time, my remaining time, to Ms. Royal. But I do have a statement that I would like to present. Mr. BURLESON. Very good. You may proceed, Ms. Lane. Ms. LANE. Mr. Chairman, and committee members, my name is Laura Lane. I am a transplanted Texan living in Philadelphia, Pa. I own a 400 acre farm in Louisiana which I bought on the install- ment plan in 1940. That took some scrimping, because at the time I was making $150 a month. I made my final land payment in 1958. Since then the value of my property has multiplied 10-fold, but the exemp- PAGENO="0828" 814 tion, as other people have been telling you, has not been increased by a dime. If this day should happen to be my last, my heirs would have to sell about half of my property to pay Federal estate taxes, leaving an un- economic unit, so that the remainder of the farm would also have to be sold, probably to a large timber company, since I have a tree farm. The principal reason for that unavoidable forced sale would be the outdated exemption. But another reason is that the Tax Code discrimi- nates against me and my heirs because I have chosen not to marry. In addition to being the owner of a farm, I am self-employed-a freelance writer. Among my clients, the principal one is Farm Journal, a national magazine with a circulation in excess of 1.5 million families. My title is contributing editor. For a long time I have felt that section 2040 of the Internal Revenue Code discriminates against women who are widowed while holding the farm in joint tenancy. In effect, you are telling a woman who has worked alongside her husband in the fields, with livestock in confine- ment or on the range, who has coped with ledger sheets and shared in sticky decisions, that her efforts to pay for the place are not a contribu- tion with money value. Yet the efforts of her hl4sband are viewed in a far more favorable light, because the entire value of the property is assumed to belong to him. The burden of proof of contribution rests unfairly on women because they are women, according to the usual interpretation of IRS and the courts. In some States-South Dakota for one-a woman's efforts to document her contribution have been an exercise in futility. And I have attached a case example of this discrimination to my testimony. But with a single provision in a new law you can change this arbi- trary inequity. Few people outside of agriculture recognize what has happened- and rather suddenly-on the farm. For example, acreage per operator has gone up and the number of workers has decreased, and I could cite a bushelful of statistics, but you don't need them. The efficiency and productivity of the American farmer-and his wife-are the marvel and envy of the world. The hired man Robert Frost wrote about has become as extinct as the passenger pigeon. Who took his place? The farm wife and the farmer's children. But she came into the business power structure with a new role; she was forced into full partnership, and she has adapted in amazing fashion. Her latent talents for management and for speaking out have emerged and blos- somed. Farm wife partnership is an economic fact of life and the laws of some States-notably Iowa-now reflect this. The Federal laws and regulations must also be altered. Last summer I wrote an article about a woman who publicly has protested this injustice, Mrs. Doris Royal on my left, from whom you have heard. I entitled my story about her "Let's Get Rid of the Widow's Tax," and that phrase "widow's tax," has become part of our social lingo. I have seen it in the New York Times. I have seen it in the Congressional Record, and I have seen it in many publications. Because of this story, I had received by last Friday 4,809 pieces of mail. I suppose the best word to describe people's ieaction to what they learned was outrage. PAGENO="0829" 815 Now, I know you have received mail, too, because I have gotten copies of it. But your mail was more polite and reasoned than mine. People's fury was spilled on me. I have been a "wailing wall" for peo- pie who have had to sell their farms or mortgage them to pay the es- tate taxes. But my work will continue. I have embarked on an open ended series of articles to tell our read- ers how legally they can avoid estate taxes-if the law is not changed. Already I have been writing about how they can incorporate the family farm-the pros and the cons-how to set up a legal partnership be- tween husband and wife who hold their property as tenants in common. In short, I am dealing with all the devices that attorneys can employ to solve the dilemma of my readers. I am going to be writing soon about trusts and private annuities. Why do I do all this? I repeat, to help keep these businesses in the farm family. For once these businesses are bought up by corporations, there will be no estate tax to pay, since a corporation does not die. But presently the estate tax laws are forc- ingthe trend to the corporate form of farm business. Finally, the saddest letters I get come, as I said, from the people who already have been forced to sell. Mostly they come from widows who feel cheated, "like an unpaid servant," a woman from Arkansas wrote me. Other women feel they have been forced to pay for the farm twice because their contributions were not legally recognized. Both men and women say they regard the present estate tax as a form of confiscation. Recently the president of a large bank told an audience of agribusi- nessmen: When the farm is recycled from one generation to another, every 25 years, succession taxes take a big bite out of its total value, As a result, there is a disappearance of private capital that will require years to regenerate, if Ft can be done at all. In the 40 years I have been a journalist I have seen billions of dollars spent to make farming a self-perpetuating business. But now it seems that what Congress has given with one hand it is taking away with the other. I urge you to bring estate and gift taxes into the economic climate of 1976. Make these laws fair to women as well as to men, to the single as well as to the married; to the farmer and the small, investor; to those with small family businesses; to all who won't let work and thrift become obsolete as this law now is. My plea is, make these laws reasonable. This is in the national interest. Mr. Chairman, I thank you for the opportunity to present my views. [The prepared statement and attachments follow:] STATEMENT OF LAURA LANE, PHILADELPHIA, PA. - Mr. Chairman, committee and staff, my name is Laura Lane. I live at 2018 Spruce St., Philadelphia, Pa. 19103. I own a 40Q~acre farm which I bought on the installment plan in 1940. That took some scrimping, because at the time I was making $150 a month. Two years later the specific Federal exemption applying to all estates was set at $60,000. That was in 1942. I made my final land payment in 1958. Since then the value of my property has multiplied 10-fold, but the exemption has not been increased by a dime. If this day should happen to be my last, my heirs would have to sell about half of my property to pay Federal estate taxes. The principal reason for that unavoidable forced sale would be the out-dated exemption. Another reason is that PAGENO="0830" 816 the Tax Code discriminates against me and my heirs because I have chosen not to marry. Settling my affairs to file the return and pay the tax within the space of nine months would be an added hardship. In addition* to being the owner of a farm, I am self-employed-a freelance writer. Among my clients, the principal one is FARM JOURNAL, a national magazine with a circulation in excess of 1'/2 million. My title is contributing editor. For a long time I have felt that Section 2040 of the Internal Revenue Code discriminates against women who are widowed while holding the farm in joint tenancy. In effect, you are telling a woman who has worked alongside her husband in the fields, with livestock in confinement or on the range, who has coped with ledger sheets and shared in sticky decisions, that her efforts to pay for the place are not a contribution with money value. Yet the efforts of her husband are viewed in a far more favorable light. The `burden of proof of contri- bution rests unfairly on a woman because she is a woman, according to the usual interpretation of IRS and the courts. The entire value of the property is assumed to belong to the husband. In some states-South Dakota for one-a woman's efforts to document her contribution has been an exercise in futility. With a single provision in a new law, you can change this arbitrary inequity. Few people outside of agriculture recognize what has happened rather sud- denly to women on farms and ranches. Acreage per farm operator has increased rapidly. Farm workers have decreased. I could cite a bushel of statistics, but you don't need them. The efficiency and productivity of the American farmer are the marvel and envy of the world. The hired man Robert Frost wrote about is as extinct as the passenger pigeon. Who took his place? Usually the farm wife with help from the children. But she came into the business power structure with a new role; she was forced into full partnership, and she has adapted in an amazing fashion. Her latent talents for management and for speaking out have emerged and blossomed. Farm wife partnership is an economic fact of life; the laws of some states, notably Iowa, have been changed to reflect this new neces- sity, this actuality. The Federal laws and regulations must also be altered. Last summer I wrote an article about a woman who publicly has protested this injustice, Mrs. Doris Royal of Nebraska, who is here today with her husband and will present her own views. My story about her was entitled "Let's Get Rid of the Widow's Tax," and in it I explained to farm couples what their situation is with regard to estate taxes. Now that phrase, "the widow's tax," Is in wide cur- rent use. I have seen it in the Congressional Record, the New York Times and in many country weeklies. Because of this story, I had received by last Friday 4,800 pieces of mail. I sup- pose the best word to describe people's immediate reaction is outrage. You have received mail, too-I know, because I've seen copies. But the tone Is more polite, more reasoned. People's fury was spilled to me. Since then I have written other articles to tell our readers how legally they can avoid estate taxes. .. pros and cons of incorporating the family farm; how to set up a legal husband/wife partnership with property held as tenants in common-all the devices attorneys can employ to solve their dilemma. Soon I will be writing about different kinds of trusts and private annuities All of these stores are designed to keep the business within the farm family. Once these family businesses are bought up by corporations there will be no estate tax, for a corporation does not die. Presently the law is forcing a trend to the corporate form of business. The saddest letters I get come from people who already have been forced to sell farms because of estate taxes. Mostly they come from widows who feel cheated . . . "Like an unpaid servant," in the words of a woman in Arkansas. Other widows say they have worked to pay for the farm twice. Both men and women say they regard this tax as a form of confiscation. I recall one letter from a man in Capistrano Beach, Calif., who recently had settled his mother's estate. He said: "IRS is killing the goose that laid the golden egg. It's too late for me to save the farm that's been in my family for three generations. But I can do something about up-dating the laws and regulations." Recently the president of Chase `Manhattan National Bank told an audience of agribusinessmen: "When the farm is recycled from one generation to another, every 25 years or so, succession taxes take a major bite out of its total value, with a reduction of the farmer's return on investment. As a result there is a dis- appearance of private capital that will require years to regenerate-if it can be done at all." end of quote. PAGENO="0831" 817 In the 40 years that I have been a journalist, I have seen billions of tax dollars spent to make farming a self-perpetuating business. But it now seems that what Congress has given with one hand it is taking away with the other. I urge you to bring estate and gift taxes into the here and now, the economic climate of 1976. Make these laws fair to women as well as to men, to the single and the married, to the farmer and the investor, to those with small family businesses, to all who won't let work and thrift become obsolescent as these laws are. My plea is: Make these laws reasonable. I thank you. BERESFORD, S. DAK., December 1, 1975. Re: Federal Estate Tax Joint Tenancy Property (Records to prove contribution). DIRECTOR OF INTERNAL REVENUE SERVICE, Aberdeen, ~. Dak. DEAR SIR: My husband and I have been married since 1966. Since then we have made a down payment on our farm and have substantially increased our net worth. After discovering that I will have to prove my contribution to the farm if my husband precedes me in death, I would like to know just what kind of records I need to keep In order to substantiate my money contribution to the farming operation; and also how do I document my physical and management contribution? Example 1. I was employed 4~/2 years as a teacher. The first 2'/2 years the money was directly absorbed into the farming operation. How do I document this actual money contribution? Example 2. I am half the farrowing operation-giving shots, clipping teeth, docking tails, etc. Do I keep track of my actual hours like I do for hired help? Example 3. I take care of all farm records and participate In all management decisions. How do I receive credit for this? Example 4. I contribute countless hours of physical labor to all phases of the farming operation. Again, do I keep record of the actual hours? I could continue, but it all boils down to the issue of a wife having to prove her contribution to an enterprise she Is as much a part of as her husband. Please answer this with the appropriate way for me to document my services in the coming years. Also, can I estimate hours worked in the past based on a farm daily reminder and other farm records? Thank you. Sincerely, (Mrs.) SHARON L. JENSEN. INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY, Aberdeen, S. Dak., December 15, 1975. Mrs. SHARON L. JENSEN, Beresford, S. Dak. DEAR MRS. JENSEN: This Is in response to your letter of December 1, 1975 con- cerning the records you should maintain to substantiate your contribution to a farming operation for estate tax purposes. Regarding your first question, the Internal Revenue Service has always rec- ognized a contribution made to a family operation by a surviving wife from earnings unrelated to a farming operation. Copies of your Federal Income tax returns and forms W-2, applicable to each year, will serve as adequate documen- tation for contribution purposes. Your other three questions relate to how you can document the services you perform in the day-to-day operations of the farm for the purpose of determining your contribution for Federal estate tax purposes. The value placed on such services which could be used in determining your contribution to the farm operation if your husband precedes you in death would be subject to the laws of the State in which the property is located. This gen- erally accepted principle of law is discussed in Revenue Ruling 72-443, Cumula- tive Bulletin 1972-2, Page 531. A copy of the ruling is enclosed for your consideration. Under the existing laws of South Dakota, the services rendered by a farm wife, freely volunteered, are considered as gratuitously given by reason of the marital contract. You could not, therefore, assign a value on your services in computing your contribution for Federal estate tax purposes. PAGENO="0832" 818 To establish all acceptable contributive value, there must be a legal relation- ship between tile husband and wife other thaii the marriage license. This could take the form of a written Partnership agreement. For additional advice or assistance, you should seek the services of one who is knowledgeable in the field of estate tax planning. Your comments have highlighted an area of concern which may be of interest to other taxpayers. We plan, therefore, on issuing a news release in the near future to discuss tile points covered in your letter. Hopefully, our response to your questions has been adequate for your iurposes. Please feel free to contact us if you should require any additional information. Sincerely, JohN B. LANGEII, Di.strict Dircetor. CAPISTRANO BEACH, CALIF., September 21, 1975. Mr. RICHARD BRAUN, Managing Editor, Parrn~ Jowraai, PMlatlelphia, Pa. Dear Mn. BRAUN, You're going to be losing a long time subscriber . . . and not because I don't like your magazine, it's because I've lost the farm land. I know you have an interest in the problem T'm about to describe, because I've read several articles ~n the subject in Farm Journal (exalllpie: Let's Get Rid Of The Widows' Tax by Laura Lane, September 1975). I've enclosed a copy of a letter tilat I wrote to tile IRS several weeks ago relative to the Estate, Inheritance, and Death Taxes that combined with inflation will soon wipe out the small, father-to-son One Family Farm. That is the type of farm that has always been called `The Backbone of America." Several months ago my nlotiler passed away and w'e started tile simple process of changing tile title from her name to mine. It ~S 110 longer simple . . . in fact, it is impossible. 1 had to sell. For me and lily family, it was a financial catastrophe. We have just lost the finest, and safest investnwllt in tue world. It is the only investment that I really know and understand. Most important, at my age (57), Our Land had a built-ill hedge against inflation. If and when there is any money left from the sale after two or niore years of waiting at 10 to 20% inflation each year on top of about 50% estate taxes, where and how can the remaining 25% be invested to assure me and my family a collifortable income, so w'e ~~`ill not have to depend upon government assistance? I have devoted years of time and a great (heal of energy to tile preservation of my family estate. We had a saying ill our family, that if w'e took good care of tile hand . . . it would take good care of us during our declining years. It worked too for my grandparents, and my parents, and they were never burdeiis 011 society. There was one thing for sure though . . . they kept the land. It's too late for me to have the land. It's gone, but we can (10 something about up-dating the laws, rules and regulations, so there is a much larger exemption before taxes. The $60,000.00 exemption shlould be increased to about $200,000.00 to preserve small (like 320A) family farnis. That's all the larger our farm was, and I couldn't even save it. If I had borrowed the tax money at 9% (Land Bank), I would have been in debt the rest of my life. The farm was not large enough to sell part and save the rest. Faying the taxes would have been like buying the farm all over again from the Internal Revenue Service, and they didn't have the deed. They had a righlt. That's wrong. LET'S GET (`RACKIN' ON THIS The backbone of America is being broken at a time when everyone is talking about "Saving the Small Farm and Farmer." Tile IRS is killing the goose that lays time golden egg. The big corporations that are buying up the small farms will never pay another deatil tax on the land, because a corporation never dies. Forniing trusts and corporations w-ithin families seems to be tue only way to go now, so get set, everybody, and hire yourself a string of corporate attorneys. Wouldn't it be better for the IRS to take less amid leave a little for us? Sincerely, WILLIAM G. Cox. oft PAGENO="0833" 819 I am very anxious to do all I can to correct this situation. I have sent letters to my Congressman and Senator. If quoting or re-printing portions of this letter will help, I'm willing. READERS FIGHTING MAD AT UNFAIR ESTATE TAXES Shock, anger and determination to do something now about unfair estate tax laws and regulations came through loud and clear in letters we've received in response to the "widow's tax" story In October issue. Fortunately, there's still time for more to get on the bandwagon for estate tax reform. Response to ~ur September story, "Lets' Get Rid of the Widow's Tax," showed 100% support for Doris Royal and her Nebraska campaign. Not a note of dissent in the first 1,000 letters! Reactions: It was a bombshell to many that if husband and wife hold property in joint tenancy and the husband dies first, IRS assumes the entire value of the property belongs to the husband . . . no matter how hard the wife has worked on the farm to help pay for it. "We are recovering from shock and amazement as to the facts," writes aMichigan woman. The discrimination is no surprise to women who have lost their husbands: "As a farm widow who found out a wife is just an unpaid servant, I am interested in changing our laws. It is too late for me, but maybe I can help others."- Arkansas Letters from men (almost half) often mentioned inflation in land values since the individual exemption was set at $00,000 in 1942. At that time a Congress- man's salary was $10,000; It is now 4'/2 times that-$45,612, a landowner in Washington says, "By that logic, why shouldn't the exemption be multiplied by 4~/2 and rise to $270,000?" HOW DO YOU LOBBY, ONCE YOUR DANDER IS UP? 1. "Work to ~et a favorable bill out of committee and on the floor of the House and of the Senate, otherwise we get nowhere," says Doris Royal. This means writing your views to Les Ullman, Chairman, House Ways and Means Oommittee, Washington, D.C. 20515. Also to Russell B. Long, Chairman, Senate Finance Committee, Washington, D.C. 20510. 2. Use petitions with people who won't bother to write letters. A hardware merchant in western Nebraska paid for newspaper and radio ads to let people know they can sign petitions in his store. Feed dealers, bankers, tax consultants are displaying the petitions for people to read and sign. A Texas woman got our permission to reprint Farm Journal's article and the petitions in her local paper. If you want copies of Doris Royal's two petitions, send a big stamped, self- addressed envelope to Estate Plan Ohanges, Farm Journal, 230 W. Washington Square, Philadelphia, Pa. 19105. UNIrx CONGRESS TO HELP END THE WIDow's TAX Farm wives who work alongside their husbands now can press for specific legislation which `would end IRS discrimination against them if they were widowed while holding the farm in jonit tenancy. Congressman Charles Thone (B., Neb.) has introduced House Resolution 7521 which would change the Internal Revenue Code of 1954 by providing that "a spouse's services shall be taken into account" in determining if she contributed. What `Congressman Thone calls "sweat equity" would qualify her for exclusion from the Federal estate tax. Wives likely would have to keep work diaries. IRS now assumes in such cases that the entire value of the property belongs to the husband. An identical bill, H.R. 11657, was introduced Feb. 3 by Congressman Mark Andrews (R., N.D.). Both make it `clear that work by a spouse "shall be treated as consideration in money or money's worth." IRS and the courts maintain that wives of farmers and owners of small businesses have worked "for love and affection" only, not for the business. Farm Journal believes it"s no accident that this legislation was first drafted by a `Congressman from Nebraska where a farm wife, Mrs. Lloyd (Doris) Royal, is rallying support for modernizing estate tax law. PAGENO="0834" 820 What's the next step? "Readers must now put pressure on the House Ways and Means Committee to include the sense and intent of HR. 7521 in any estate tax bill it reports out of Committee." Doris Royal said in a telephone interview. "Otherwise we'll have to start all over." Phe `Committee now has 149 `separate bills on estate taxes to consider, so it would be easy for relief of widows to get lost. Address your letters to the House Ways and Means chairman. The Honorable Al Ullman (D., Ore.). 1102 Long- worth Office Bldg. House of Representatives, Washington, D.C. 20515. Will `Congress act soon? If it is pressured. House Ways and Means hearings are scheduled March 15-19. Doris Royal hopes to testify and present petitions collected by FarmS Journal readers. Laura Lane. PAGENO="0835" 821 LET'S GET RID OFTHE WIDOW'S TAX Reprinted from the September Issue of Farm Journal Copyright 1975 Farm Journal, Inc. Philadelphia, Pa. 19105 PAGENO="0836" 822 LET'S GET RID OF THE WIDOW'S TAX By LAURA LANE Contributing Editor It's time estate tax laws got updated so a farm can stay in the * "A farm wife doesn't know family, readers say. how the government discrimi- nates against her until she is What can you do? widowed or divorced. My hus- Support this Nebraska band and I worked hard these campaign now gath- ~ to make la~d enng momentum died at 45. Now I'm having to pay for the farm again-this time to IRS."-Nebraska Informed couples are eager for a change in estate tax laws, our mail shows. But is Congress? The House Ways and Means Com- mittee has on its calendar at least 15 bills aimed at reform of tax structure, yet that doesn't guarantee action. To get the job done we need more people like Mrs. Lloyd Royal of Sarpy County, Neb. "One day I learned that if something happened to my husband, I'd probably have to mortgage the farm to pay the estate taxes," she told me. That was five years ago. Doris Royal waited for "someone to get up in arms about the injustices." Nobody did. Meanwhile, land values have climbed, making her more vulnerable and endangering the inheritance of the Royals' son and daughter. Doris has never thought of herself as a leader or political cru- sader, but she has a high Indignation Quotient. So she began what later became a campaign by enlisting the help of Mrs. Jerry (Annie) Knapp. Mrs. Robert (Sylvia) WuIf, and Mrs. Bill (Evelyn) Clark. Among them they can do just about everything that needs doing on a Nebraska farm. . . spread manure, keep books, operate machinery, type letters. They have become a good team for arous- ing public sentiment and applying pressure. What they lobby for: Let's get rid of The Widow's Tax! "That discrimination is enough to turn a farm wife into a libber." acknowledges Phillip A. PAGENO="0837" 823 Henderson, Nebragka Extension economist who fuels the reform movement with information. The situation: If husband and wife hold property in joint tenancy and the husband dies first, the entire value of the prop- erty is assumed to belong to the husband and is subject to estate taxes-unless the wife can prove that she inherited part or held an off-farm job to meet pay- ments or otherwise made a legally recognized contri- bution of money or ,"money's worth." Proof means cancelled checks, mortgage re- leases, etc. Didn't the wife con- tribute by driving the tractor, sorting cattle, doing bookwork? Not in the eyes of IRS. "The wife renders all these ser- vices as a part of her marriage contract," an IRS attorney ex- plained, when I asked him about this interpretation I pressed him for an example of when a wife does contribute. "The classic case is a Mom and Pop grocery store where the wife draws ,p salary and pays Social Security tax." Earlier Doris Royal had show- ed me sheaves of letters from widows burdened with this tax If there is such a thing as `his' and `her' money, it is `my' school teaching pay that we used to buy this farm in the first place, but I'm having trouble proving it." Another reason for your keeping good records! Everywhere I travel-not just in Nebraska-I find farm wives hurt, dismayed and angered at the IRS interpretation We are contributing greatly to the acquisition of land and machinery with our labor," a woman wrote the Nebraska Commission on the Sta- tus of Women. "We, along with our husbands, in- creased our net worth over the years-the difference being that later we women are told we didn't earn half and when it is `given' (willed) to us we have to pay tax on it." Convictions like this have led to changes in laws of a few states-Iowa, for instance. Wisconsin Women for Agriculture `recently have sought legislative changes, too. In June their Senate voted to alter inheritance laws so the farm wife would not have to "prove her contribution." "I know we can hire a lawyer to change our legal setup," Doris Royal says, "but I want what I've work- ed for and am entitled to. We women who have tak- en the place of hired men deserve fair treatment un- der the law." So this winter she spent over 40 hours a week working forjustice she feels she is denied. A second disadvantage of holding the farm in joint tenancy: "Upon the wife's subsequent death the same property will be taxed again to the heirs-usual- ly the children-the rate depending on how long she outlives her husband. It's even higher if she survives him by 10 years. Also a widow or widower has no marital deduction. So it's not uncommon for two People want the facts, so you have to be prepared for explanations about laws governing estate taxes, says Doris Royal, left, who is spearhead oft/se reform cam- paign. Here she has the help of a neighboring farm wife, Sylvia Wuif, center, in collecting signatures on a petition ata convention of Nebraska's Federation of Democratic Women. deaths to take as much as 25% to 50% of a farm estate," Dr. Henderson told me. How common is it for farm couples to hold prop- erty in joint tenancy? One Nebraska attorney said 50% do; the IRS lawyer said 9 of 10 farm estate tax cases he handles. Why? This way of holding property originally meant a saving in probate expense-costs now usually much lower than estate taxes, Also, it's a great convenience to hold a car or bank account in joint tenancy when one partner dies. A widow often has other problems. Dixon 0. i~dams, Nebraska attorney who is donating time to the reform movement, gave me this instance~ "Some banks are reluctant to lend money to a widow-she hasn't proved she can manage. Just now I'm helping a woman mortgage a farm to pay off estate taxes." IRS' interpretation of "contribution" isn't limited to farm wives-it applies to other businesses and pro- fessions where the wife is receptionist, bookkeeper, secretary and general flunky. For this reason, Doris Royal seeks and gets the support of diverse groups such *as Chambers of Commerce, senior citizens' clubs, Shriners, altar societies, the Nebraska Com- mission on the Status of Women, dentists' wives, livestock feeders associations and Farm Bureaus. The personaJ exemption needs a big boost be- cause of inflation since 1942. IRS was ready to propose legislation raising the specific exemption for 68-872 0 - 76 - 54 PAGENO="0838" 824 every estate from $60,000 to $100,000 or maybe $120,000 when Watergate and the enemies' list caused them to seek a low profile, an insider told me. The increase from $60,000 is a reform everybody can support, believes William V. Brooks, Sarpy County commissioner and oil dealer. He is cam- paigning for new estate tax legislation through trade journals, business organizations, petitions, and one-to- one politicking. "Many small businesses like mine don't have liquidity to pay a big tax-we need to put everything back Just like farmers do he told me And of course the value of our property too has in creased dramatically in 33 years It s time to change the way land Is valued for estate tax purposes. As of now, estate taxes often are inflated because the farm or ranch is appraised at its anticipated market price-its "development" value- not on its ability to produce crops or livestock. This inflationary factor often means "when death comes along, land and equipment hit the auction block," writes George R. Baker, Spokane County, Wash. We need more time to "settle" an estate and file estate tax returns. "The nine months allowed af- ter a person s death aren t sufficient-especially if there has to be a distress sale of land or property," says Doris Royal. Attorney Adams agrees. Farm people can get the needed legislation if they rally the support of other citizens who care enough to use political muscle. Nebraskans are sup- porting H.R. 1793 introduced in the House by Rep. Omar Burleson (D., Tex.) and its identical twin, S. 1173, introduced in the senate by Senator Carl T. Curtis (R., Neb.). This bill has 60 sponsors, and has been endorsed by all the Nebraska delegation. "It doesn't include everything we might like, but it comes close," Doris Royal says. What it provides: * An increase in the exemption allowed every estate from $60,000 to $200,000. * An increase in the marital deduction by a flat sum of $100 000 beyond the present one half (Notice this means less financial burden on a surviving wife but does not alter the discnminatoiy disregard for her contribution" where property is held jointly.) * A method for valuing real property-farms, wood- land-on the basis of current use rather than on any potential use at higher value Your Congressman can get you a copy of this bill or some of the others which would change estate tax laws, including House Resolutions 2048, 3871, 3903, 3915, 2417, 3879, 1349 and Senate Bill 277. Your state inheritance tax laws probably need up- dating, too. The Nebraska group supports Legislative Bill 585 which specifically provides that if husband and wife hold property in joint tenancy, "it shall be assumed that each spouse contributed equally to the acquisition of the property unless the surviving spouse' shall prove that his or her contribution was greater than one half the cost of such property." How to lobby for your Ideas about changes: 1. Write your Representative and Senators, send- ing copies to Al Ullman (D., Ore.), Chairman of the House Ways and Means Committee, Washington, D.C. 20515 and Russell B. Long (D., La.), Chairman of the Senate Finance Committee, Washington, D.C. 20510. Even if you get brush-offs,,keep plugging. "Thoughtful, convincing letters probably do the most good, but we know a lot of people won't go to that trouble, so we use petitions, too," Doris Royal says. Recently copies of petitions in behalf of H.R. 1793 with 3,365 signatures were delivered to key peo- p~e in Congress-signatures Dons and her co workers had collected I saw people mterrupt her lunch in a restaurant, eager for a chance to sign! 2. Bone up-then speak out on proposed legisla- tion. That means speaking at legislative hearings, state conventions or to small informal groups, being interviewed by the press and TV. It's especially help- ful to have a lawyer on your team. "I don't know where we'd be without the counsel of Dixon Adams," Doris says. Also you need people who type or mime- ograph, stuff envelopes, do research, work on posters and other visual aids. 3. Accept every offer of help. "You can't expect to agree on every issue under the sun, but you can cap- italize on your mutual dissatisfaction with present es- tate tax laws," After an interview appeared in the Omaha World- Herald, Doris had such a voluminous correspondence she had to resort to duplicated form letters. She can't spare a lot more time from the livestock or the tractor, so if you want copies of her petition in sup- port of H.R. 1793 and her covering letter, don't write her-write us. Send a stamped, self-addressed envel- ope (big) to Estate Plan Changes, Farm Journal, 230 W. Washington Sq., Philadelphia, Pa. 19105. -J You will find more on estate planning and taxes in OUT LOOK Farm Journal s thriving monthly NEWSletter Also concisely covered: Money management, real estate, for- eign markets, upcoming legislation. alerts to goverment regulations, commodity outlooks and trends, practical helps with paperwork in the Executive Secretary insert. Introductory price: $9.95 per year. Write OUTLOOK, Farm Journal, Inc., Philadelphia, Pa. 19105, Here's how proposed changes in estate laws could affect tax arithmetic Assume wife inherits 100% of estate as a surviving joint tenant She is unsalarled and has not inherited any of the land As law As proposed now stands under HR. 1793 Value of estate $350 000 $350 000 Lees marItal deductIon 175,000 275,000 175,000 75,000 Less exemption 60,000 200,000 Taxable estate 115,000 0 Estate tax 25,200 0 PAGENO="0839" 825 Mr. BTJRLESON. Well, thank youu very much, Miss Lane. Again we will have to apologize, we have to go vote, but we will be right back. Mr. FRE~ZEL. Mr. Chairman, would you yield? Mr. BURLESON. Yes, of course. Mr. FRENZEL. I am not going to be able to come back, and I want to thank the ladies for one of the best presentations we have had be- fore the committee, and the gentlemen as well. It has been an excellent afternoon and we thank you. Mr. BURLESON. Thank you very much. Please excuse us. We will be gone not more than 10 minutes, I hope. Mr. BURLESON. Ordinarily we don't start without somebody on one of the two sides, but I think under the circumstances with time passing we had better continue. We should have had arrangements before to serve tea and crumpets while we had to be away. Food, anyway. Ms. Furber, do you have something to offer? STATEMENT OP IACQUELINE J. PURBER Ms. FUmiER. Yes. I `am Mrs. Jacqueline Furber. I am here today representing Furber - Farms and the many listed names who are farmers, all own farms. Mr. and Mrs. George Green, Fowler brothers, George J. Mitchell, Cliff Kunes, Jr., Mr. and Mrs. Ronald Eygnor, Mr. and Mrs. Fritz Wafier, Mr. and Mrs. Glenn Chapin, Mr. and Mrs. Robert Chapin, Mr. and Mrs. John Salisbury, Mr. and Mis. Merritt Thomas, Mr. and Mrs. Russell Frear. I am representing also Wayne County Farm Bureau and Women for the Survival of Agriculture in New York. There is concern on the farms of this country, over the estate tax situation, bordering on panic. Farmers, who a short time ago, perhaps had no more than a will, are rushing to their lawyers to try to figure out elaborate estate plans that will allow their farm families to con- tinue farming the family acres. I had intended, when I first requested the opportunity to testify at this hearing, to represent only Furber Farms. However, my farm neighbors and the organizations mentioned insisted that I include them and they all contributed money for me to come here. I even had calls, late last week, from farmers I didn't even know, who were so deeply concerned that their plight be told in Washington, they offered me, a perfect stranger, all the financial aid I needed to get here. The economic situation of the late 1960's and early 1970's has pres- sured the little people of our country to get involved and speak out for long overdue reforms in many areas of Government as a means of survival, rather than simply equity or convenience. My husband and I just narrowly escaped extermination as "family farmers" when my father-in-law died in 1974 and left us his farm. We certainly became painfully aware of the obsolescence of the current es- tate tax as it applies to family farms. It is rarity today for an individual to have the capital to start a totally new farming operation. Therefore, most of the family farms now operating are businesses that have been passed from father to son. Our farm's history is typical of most of today's fulitime "family farms." PAGENO="0840" 826 The original nucleus of Furber Farms was purchased in 1931 by my husband's father, when he was a young farm lad, just starting out during the depression. It was, for many years, a diversified sort of operation, a few cows, chickens, numerous field crops, orchard, and so on. My husband was born and brought up on the farm, and as is tradi- tional, at a very early age, became an important part of the farm labor force, gradually learning and mastering the multitude of skills necessary to farming. His wages were the privilege of sliding his feet under the family table. Over the years as some of the neighboring farmers died or moved on, our acreage increased, field by field, to the moderate size of ap- proximately 550 acres. We have a tall stack of deeds and property searches to attest the piecemeal growth. By growing, farms could use technology and improved machinery with more efficiency. As with most of today's farms, the diversified op- eration gave way to specialization, in our case fruit growing. Our farm has had its share of hail, freezes, droughts, infestations and other assorted catastrophes that all farm families risk on a year-in-year-out basis. The farm has been mortgaged and remortgaged for most of its 40-odd year history, either to offset bad crop years, poor price years, or as a means to expand or make improvements. Some of the trees that were planted by my husband's father will still be bearing fruit when his grandchildren are grown and in charge of the farm. And so the business of producing food and fiber on family farms continues from generation to generation. Some of the farms I repre- sent here today are New York Century Farms. They have been in the same families for over 100 years. My father-in-law had done some estate planning by providing in- surance and I know he would have bought more if he could have af- forded the premiums. Unfortunately, the insurance benefit, though it was sizable, was not enough. I really believe that no one, unless they have gone through the experience of a farm estate settlement, can have any realization of the tremendous amount of capital one must raise. Fees abound: Federal estate tax, State inheritance tax, funeral costs, administrative costs, income taxes, appraisals, attorney's fees, and on and on. The bill gets bigger and your spirits get lower. Remember, too, that on a farm you can't hang a wreathon the door and lock up. So the problem becomes not only that of raising the capital neces- sary to settle the estate, but also to continue the business of producing food. We happened to be in the middle of apple harvest when my father-in-law died. Believe me, we had little time for grief. Ripe apples will not wait through the proper period of mourning. The information one must dig up to fill out a Federal 706 form is mind bending and time consuming. It was actually months before we knew the total estate liability and then the question was, could we scrape together the money to cover it and keep the farm intact. There were many times during that anxious period when we hoped that no- body else died and left us anything. In the final analysis, it became clear that keeping the farm depended on finding a buyer and selling a nortion of it, keeping in mind that we must retain enough property with which to make a living. Fruit farms PAGENO="0841" 827 are not exactly hot property lately, but fortunately we found a buyer. We were forced to sell 100 acres, building~, and some machinery. We did not get as much as we should have for the property because we did not have the option of time to sell at the best advantage. Our financial stability, because of this sale and the total impact of the estate settle- ment, is now strung so very tight, that it will be years before we recover, even under the best of conditions. With this bitter experience still fresh in our minds, my husband and I are well aware of the problem we now face in assuring that our two sons will be able to continue the farm operation. With property values still inflating, and no end in sight, even good estate planning has limitations and the nature of farming further limits the use of the measures now commonly instituted to evade estate taxes. Because farm estates are comprised of land, buildings, and machin- ery, it is difficult to put definite parcels in the form of gifts, and giving such property limits our ability to raise operating capital through mortgages. Adequate insurance coverage would seem a reasonable solution. Frankly, we cannot afford the premiums. While farmers may be thought of, by urbanites and suburbanites, as "wealthy landown- ers," in truth, farmers usually exist under the "live-poor die-rich" rule. The income from our large investment is not all that great. Now the question is-Is the "family farm" worth saving? I read recently in a Government publication this statement: "From the strengths of our social heritage, the lifestyles of the family farm are worth maintaining." "Lifestyles worth maintaining," indeed! Who do they think feeds them? Phase out the family farm and you have delivered our future food supply into the hands of the same nice folks who have tied up pricing in most all our other American industries and made our agricultural products our last real international trade commodity. Loss of the "family farm" will have snuffed out the last competitive feature of our food supply system. The Government's intention in levying estate taxes may be to collect revenue but in practice these taxes are destroying productive, com- petitive, and necessary units of our society. If "family farms" are to survive, revisions of the Federal estate tax law should incorporate the following concepts: First. The outdated $60,000 exemption figure must be raised to fully compensate the effect of inflation. I am not an economist, but I believe from my reading this would be no less than $200,000 to $210,000. Second. Farm land evaluation for estate tax purposes should be based on the agricultural use value rather than the higher potential use value. Third. There should be a more liberal marital deduction than the current 50 percent. Fourth. The farm wife's contribution of labor should be recognized. Fifth. There is merit in the proposal that the estate tax payment period be lengthened to 20 years at 4 percent interest. Sixth. To cover the event of `both parents dying in a common ac- cident, provisions should be made for an exemption or tax free trans- fer of property to minor children. I thank you for the opportunity to present the views of myself and those I represent. Mr. BURLESON. Ms. Furber, thank you very much. PAGENO="0842" 828 We will ask you about this later, but your name is connected with getting exception to OSHA for certain types of tractors ~ Ms FURBER Yes, I am a rebel Mr. BURLESON. Reverend Chauncey, you have been very patient. We are ready to hear you and we welcome you STATEMENT OP REV GEORGE A CHAUNCEY Reverend CHATJNCEY Thank you, Mr Chairman My name is George Chauncey I am the Washington staff person for the Presbyterian Church in the United States, and chairman of the Interreligious Task Force on U S Food Policy It is in the latter capacity that I appear before you this afternoon I welcome this op portunity to offer testimony on behalf of the task force I have already submitted a formal statement and now I want to summarize the basic thrust of it. The task force is a team of Washington-based staff of over 20 na- tional religious agencies who work together to facilitate the witness of the American religious community for responsible U.S. food policy. The American religious community is deeply concerned about hun- ger at home and abroad It recognizes that as public policy has been a factor in aggravating the problem of hunger, so public policy can be a factor in solving the problem of hunger The task force exists to serve the concern about public policy of the American religious community in its deep cohcern about hunger here and aroulld the world Over two dozen national religious com munities cooperate in our work, but the task force speaks for itself only One of the policy areas that the task force focuses on is U S agricul tural policy-that is, that cluster of Federal `policies which affect the production of food by Amrican farmers to feed the hungry here and around the world. It is that concern which `brings us here today. We are advocating revisions in the current law regarding State and gift taxes for four reasons. First, we are committed to the survival of the family farm We be lieve that family farming as a means of producing food for the hungry at home and abroad should be continued Second, we believe that justice demands that our Nation give the family owned and oper ated farm a fair chance to survive as a viable social and economic unit in our society The current structure of our estate and gift taxes, when combined with other economic factors such as the escalating cost of land and other farm inputs, unfairly stacks the deck against the individual farmer who wishes to keep his or her farm in the family Third, the current situation is contrary to the intention that Con gress demonstrated in its most recent revision of the estate tax sti u~ ture 34 years ago in 1942 The 1942 law established an exemption of $60,000 in order to protect the family farmer and the small business man or woman. However, `as many witnesses have testified, prices have skyrocketed since those good old days The combin'Ltion of a 1942 exemption and 1976 prices `has worked considerable hardship on American family farmers, and others have spoken to that from direct experience with great eloquence PAGENO="0843" 829 Finally the consequences of the current situation have been harmful for practically every sector of our society. The current situation has contributed to the disappearance of the family farm, the dissolution of the fabric of rural life, the growth of conglomerates and the loss of competition. For these reasons, the Interreligious Task Force recommends four changes in the present tax law. One, we recommend that families be provided the equivalent benefit of the 1942 exemption levels of $60,000 per estate and $30,000 per person by gifts during a lifetime. This benefit could be provided in several ways. The exemption levels could be increased. The $60,000 estate tax exemption could be updated for inflation to at least $200,000 and the gift exemption to $100,000. A second option, which we would perfer, would be to substitute a reasonable tax credit for the present exemptions. This credit should be at least $30,000. The credit would have the posiitve effect of taxing the total asset value of the estate, thereby placing the greatest tax burden upon the wealthiest landholders by reducing amounts on small farmers and businessmen and women. It would also mean approxi- mately $1 billion less would be lost to the Federal Treasury than with a straight increase in exemption levels. Thus, we prefer the approach recommended to this committee by Senator Nelson. Another way of reducing the tax burden on the small farmer would be to adjust the current tax rate schedule by making it more progressive. Any one or a combination of these alternatives would seem to us a substantial improvement over the present sitaution. And each should include an inflation escalator clause to prevent exemption credits or tax rates from being outdated in the future. Two, we recommend that recognition be given to the unique partner- ship between husband and wife in operating a family farm. In the case of many families, farming is a joint venture and involves a real partnership between husband and wife. It is simply unfair to tax a surviving spouse on an estate which he or she has been heavily involved in building. I might add parenthetically, Mr. Chairman, that given the privilege of testifying on the particular panel that I am testifying with, I am grateful to a kind providence for leading the task force to advocate that particular provision in the law. Three, we recommend that the executor of a farm estate be given the option of valuing land used in farming at its value for agricultural purposes rather than its fair market value. Under current Federal law all land, including farmland, is valued for estate tax purposes at its fair market value. Thus, land used in food production is taxed nbt on the basis of its agricultural use but on its commercial potential. This inequity, combined with the antiquated $60,000 deduction for estate taxation, has contributed to the conversion of many family farms to nonagricultural use. Finally, we recommend that the current system of allowing estate tax payments to be spread out in installments over 10 years be con- tinued, but that the interest rate on the deferred balance be reduced to PAGENO="0844" 830 4 percent from the current 9 percent. This revision in interest rate would be in line with the original intention of the law, which was to prevent undue hardship in paying estate taxes. This provision is not currently being used very widely, and the interest rates should be reduced in order to encourage its use. The task force recognizes, Mr. Chairman, that one result of the foregoing suggestions would be a reduction in the total amount of Federal tax revenue. It seems to us, however, that it is not worth the consequences of imposing such inordinate burdens upon family farms and small businesses for the small fraction of the total tax receipts currently represented by estate tax payments. It would also seem pos- sible to increase taxes on larger estates and incomes in order to make up for the amount lost through reduction in taxes on small or moderate estates and income. This would place the heaviest tax burden where it legitimately belongs, upon the wealthiest segments of our economy. The task force believes that these recommendations are reasonable and fair, and that they would contribute to the preservation of the family owned and operated farm and to the common good of our society. We commend them for your serious consideration. [The prepared statement follows:] STATEMENT OF GEORGE A. CHAUNCEY, CHAIRMAN, INTERRELIGIOUS TASKFORCE ON U.S. FOOD PoLICY Mr. Chairman and Members `of the committee, by name is George Chauncey. I am a Presbyterian minister, the Washington staff person for the Presbyterian Church in the United States, and chairman of the Interreligious Taskforce on U.S. Food Policy. It is in the latter capacity that I appear before you today. I welcome this opportunity to offer testimony on behalf of the Taskforce. The Taskforce is a team of Washington-based staff of over twenty Protestant denominations and national Roman Catholic, Jewish, and ecumenical agencies. In each of our organizations, as well as in many other national religious bodies not related to our Taskforce, hunger at home and abroad has become a major concern and programmatic priority. New programs to deal with this problem have been developed and new funds contributed. There is widespread recognition in the religious community that public policy has played a key role in aggravating the problem of hunger and that it can play a key role in solving the problem. Thus it is commonly held that one of the primary religious duties of members of the community of faith is to address public policy issues. The particular function of the Taskforce is to facilitate the witness of the American religious community for a responsible U.S. food policy. We are seeking to do this by clarifying moral issues in U.S. food policy by providing reliable in- formation about policy and policy options, by identifying policies and policy objectives which in our judgment serve the cause of justice, and by recommending ways in which concerned members of the religious community can most effectively make their witness in the political arena. The Taskforce speaks for itself only, and not for the almost two dozen na- tional religious bodies cooperating in its work. The Taskforce speaks to those bodies, to the larger religious community, to the general public, and, on occasion, to umlits of the U.S. government such as this Committee. THE GROUNDS FOR OUR ADVOCACY OF REVISIONS IN THE LAW The Taskforce, whose primary concern is for justice in the production and distribution of food, is advocating revisions in the current law regarding estate and gift taxes for four reasons. First, we are committed to the survival of the family farm. We believe that family farming as a means of producing food for the hungry at home `and abroad is a precious way of life which should be continued. Some people boast of the PAGENO="0845" 831 way in which America's energy-intensive agriculture, especially in its techno- logical forms introduced by agribusiness corporations, is making it possible for fewer and fewer people to grow more and more food. We believe that the transi- tion of recent decades toward fewer family farms and more agribusiness opera- tions is a mixed blessing which should not go unchallenged. Family farming is not only a rich part of our national heritage; it is also inherently more respectful of our fragile and precious farming land than is the care given by many of the large corporations. Second, we believe that justice demands that our nation give the family-owned and -operated farm a fair chance to survive as a viable social and economic unit of our society. The current structure of our estate and gift t'axes, when combined with other economic factors such as the escalating cost of hand and other farm inputs, unfairly stacks the deck against the individual farmer who wishes to keep his or her farm in the family. Third, the current situation is contrary to the intent that Congress demon- strated in its most recent revision of the estate tax structure thirty-four years ago in 1942. Two goals of the 1942 revisions were to protect `the family farmer and to break up excessive concentrations of wealth in agriculture by taxing those farmers with large land holdings. In 1942, $60,000 represented a fairly large farm estate. Hence, estates under that amount were exempt from estate taxes; only those at or over that amount were taxes. However, even though the asset value of the average American farm was only $50,000 as late as 1960, in recent years the cost of land and farm inputs has skyrocketed to the point that by 1974 the value of the average American farm was $170,000. This combination of "old law' and "new prices" has worked considerable hardship on family farmers. An increasing number of family farmers, for ex- ample, have been required to file estate tax returns. In 1942, only 17,000 estate tax returns (farm and non-farm) were filed, approximately one for every 60 deaths. In 1972, 175,000 such returns were required, one for every 10 deaths. Many farmers have been forced either to sell a portion of their land in order to raise enough funds to pay the estate tax or, if they could get credit, to go further into debt by borrowing at the current high rates of interest. For a significant number of these, selling off a segment of their land has meant being left with an uneconomically small amount of land with which to earn a living. Finally, the consequences of the current situation have been harmful for pra~ctically every sector of our society. For the structure of American agriculture itself, the current situation has meant that land sold of necessity by family farmers has been bought either by large agribusiness corporations or in the case of marginally suburban land, by developers who convert it to shopping cen- ters or housing developments. Between 1950 and 1974, one half-2.8 million-of the farms in the United States disappeared. Farm land lost to' commercial de- velopmen't can never `be regained. By encouraging absentee ownership, the present tax law has contributed to dissolving the fabric of our rural communities. As family farmers move out and corporations move in, communities have less need for local businesses and serv- ices. For example, a recent study by a Wisconsin economist of the effect on small communities of the sale of small businesses in them to absentee, out-of-town owners found that employment dropped and the use of local lawyers, banking services, and other community services which kept the local economy healthy was reduced. And then, for our national economy, present estate tax laws have meant greater concentration of agricultural land and wealth in the hands of fewer and fewer people, with the consequent loss of competition, accompanied by declining food quality and rising consumer prices. For all these reasons our commitment to the survival of the family farm; our conviction that justice demands that family farms 1e given a fair chance to survive; our sense that the current law violates the oviginal intention of Con- gress; and our judgment that the consequences of the current law are harmful to practically every. segment of society-the Taskforee recommends that certain changes be made in the present tax law. RECOMMENDATIONS - One, we recommend that families today be provided the equivalent benefit of the 1942 exemption levels of $60,000 per estate and $30,000 per person via gifts during a lifetime. This benefit could be provIded In several ways. The exemption PAGENO="0846" 832 levels could be increased. The $60,000 estate tax exemption could be updated for inflation to at least $200,000 and the gift exemption to $100,000. A second option, which we would prefer, would be to substitute a reasonable tax credit for the present exemptions. This credit should be at least $30,000, which could perhaps be instituted on a gradual basis. The credit would have the positive effect of taxing the total asset value of the estate, thereby placing the greatest tax burden upon the wealthiest landholders while reducing the amounts contributed by smaller farmers and businessmen. It would also mean that approximately $1 billion less would be lost to the federal treasury than with a straight increase in exemption levels. Another way of reducing the tax burden on the small farmer would be to adjust the current tax rate schedule b~1 making it more progressive. A gross estate of $200,000, for example, is under current law taxed at a rate of 30%. It would be possible to adjust the current tax rates by adopting a revision such as the following one: Ta~v rate Tavabie e8tate (aouars) (in percent) 0-50,000 50,000-100,000 10 100,000-150, 000 15 150, 000-200, 000 20 200, 000-400, 000 25 400, 000-600,000 30 600,000-1,000,000 Any one or a combination of the preceding alternatives would seem to us a sub- stantial improvement over the present situation. Each should include an inflation escalator clause to prevent exemptions, credits, or tax rates from becoming outdated in the future. Two, we recommend that some recognition be given to the unique partnership between husband and wife in operating a family farm. In the case of many families farming is a joint venture and Involves a real partnership between the husband and wife. It is unfair to tax a surviving spouse on an estate that he or she has been heavily involved in building. We would favor the elimination or substantial reduction of estate taxes when an estate is being passed on to a surviving spouse who has been involved in building that estate. The estate will in any case 1~e taxed when passing from the surviving spouse to his or her children. It seems unfair also to tax that estate when it initially passes to that surviving spouse. Three, we recommend that the executor of a farm estate be given the option of valuing land used in farming at its value for agricultural purposes rather than at its "fair market value." Under current federal law all land, including farm land, is~ valued for estate tax purposes at its "fair market value." Thus, land used in food production is taxed not on the basis of its agricultural use, but on its com- cercial potential. This inequity, combined with the antiquated $60,000 deduction for estate taxation, has contributed to the conversion of many family farms to non-agricultural uses. In one sense the valuation is real, in that the land could be sold for that price to non-agricultural interests. But it is a false valuation from the viewpoint of the farmer paying the tax, because that value does riot provide a commensurate profit to him or her. The farmer can only realize a profit by selling his or her land and going out of business. This creates a peculiar and unfair burden upon the farmey. While the govern- ment is encouraging full production of agricultural commodities which will help feed the world's hungry, the farmer is actually being penalized for producing food on the land rather than co~iverting it to commercial use. An attendant threat to future agricultural use of land exists if the farmer is forced to sell the farm. In a large majority of cases it is a nearby well-established farmer with large land holdings or a non-agricultural commercial developer who can afford to purchase the land. The latter lends itself not only to non-agricultural use of the land, but to holding actions on land that is used for speculative purposes or tax shelters when it could and should be used in the production of food. This revision providing for an optional method of valuing land would encourage continuity in the family operation of a farm and, according to the economic divi- sion of Congressional Research Service, would have a negligible effect on the total PAGENO="0847" 833 tax revenues received by the federal government. A safeguard Is of course needed to insure that a farmer's heirs could not unfairly take advantage of a reduced land valuation for tax purposes and then at some future date sell that land to commercial interests at its higher market value. Finally, we recommend that the current system of allowing estate tax payments to be spread out in installments over ten years be continued but that the interest rate on the deferred balance be reduced to 4% from the current 9%. This revision in interest rate would be in line with the original intent of the law, which was "to prevent undue hardship" in paying estate taxes. This provision is not currently being used very widely. The interest rate should be reduced in order to encourage its use in hardship cases. The Taskforce realizes, Mr. Chairman, that one result of the foregoing sugges- tions would be a reduction in the total amount of federal tax revenue. It seems to us, however, that It is not worth the consequences of imposing such inordinate burdens upon our family farms for the small fraction of total federal tax receipts currently represented Jy estate tax payments. It would also seem possible to increase taxes on larger estates and incomes in order to make up the amount lost through a reduction in taxes for small or moderate estates and incomes. This would place the heaviest burden of taxation where it legitimately belongs: upon the wealthiest segments of our economy. The Taskforce believes that the recommendations offered in this testimony are reasonable and fair, and that they would contribute to the preservation of the family-owned and operated farm and to the common good. We commend them for your serious consideration. Mr. BURLES0N. Reverend Chauncey, you have been very effectjve. If you can present an economic and political issue I am sure you are effective in the pulpit. Reverend CHAUNCEY. Thank you, sir. Mr. BTJRLESON. Of course, I wish to compliment all of the panel very highly. In most panels we have had we have had some disagreement. We are all, I think, trying to reach the same goal. Some of you have a little different approach. My proposal in the legislation certainly was not intended to be per- fect. You have some suggestions I hope we can incorporate in the amendments to improve that legislation. It was intended that it would be somewhat bare bones, that it would not have to be explained so broadly, and that it would have the essentials so that it would attract sponsors, very frankly as a matter of strategy. So much of what you have presented here, I would hope can be incorporated in amendments. I think if my colleagues would agree, I would like to recognize Mrs. Kays to have the first turn. May we do that? Mr. STEIGER. Yes, sir. Mrs. KEYS. Thank you, Mr. Chairman. As you were saying before, when we came back in the elevator, I was lamenting the fact that the very best testimony we have heard on this issue to really help people understand the real sociological problem that we have to solve has been heard today, at a time wheITi we had some very active debate and a parliamentary situation on the floor of the House that kept most of our members busy there or running back and forth, and I regret it very much. But I intend to prod each and every member of this committee to read the testimony that has been offered here today. In view of the lateness of the hour, I don't want to ask very many questions. I want to tell you, especially the farmwomen testifying here today, that I am most concerned that this which is one of the most flagrant examples of unfair discrimination in our tax code be ended. I, PAGENO="0848" 834 myself, come from a farm family. My great grandmother, whose name I bear, was one who settled in Kansas in the mid-l9th century, and I know that on any successful farm both spouses are equal working partners, and if they are not it is not successful. I have never lived on a 1~arm myself, but many of my relatives do. And I believe that in the 200th year of this country's birth it is time that we change this one very unfair, discriminating law to deliver some of those aspects of full equality that this Nation was founded on, and I intend to work very hard within this committee for it. There is one question I would like to ask of Ms. Royal. I did have a chance to spend some time with you, and you spoke to me of some of your fears regarding the example of your own estate, which at this time is still held in the name of either your parents or your husband's parents. I think you made a very eloquent statement when you spoke of the effects of three generations tied up under the financial burden of estate taxes. I really would like for the committee to heai~ about that. Ms. ROYAL. I think that is the one that I did speak about in my pre- pared statement, where the widow could not mortgage, and her children had to mortgage the property that had been handed down from her grandfather to her mother to her, and she could not get any financing to pay the tax and so her children had to mortgage their property so that she could remain on the farm and stay in her home until her death. To me this is almost unforgivable because now where will her chil- dren go? She is in her sixties and in poor health. Their property is mortgaged already to pay her tax. What will they mortgage to pay their tax? Also, I have a letter from Kansas, which I think you especially would be interested in, whi~h brings out a point that has been brought to me in many of the letters that I have received, in which they say why hold the circle of taking the savings from the old in estate taxes and putting them in effect on welfare. This man has an elderly mother who is in a rest home whose savings were taken away by the estate tax law. And he quotes, and I think it is worth taking your time. He says the satisfaction of financial security, dignity, and self- respect, is about all the elderly have left and it shouldn't be taken away. No pill can take the place of that. I think that pretty well summarizes the feeling of the people who deal with old people. Mrs. ~ Mrs. Vogel, I have one question of you. You expressed your concern, which is all of our concern, for the ability of land to remain in the family. Do you believe that a change in the way that we evaluate farm land such as was mentioned by Reverend Ohauncey would be one help to evaluate it by agricultural purposes instead of fair market value? Ms. Vow~. Yes, very much so. Just in our own neighborhood, to give you an idea of what is going on, within 6 months time, three farms within a half a mile on each side of ñs have been developed. What do you think would happen if my husband would die tomorrow? What would they assess our land value at? Our taxes have been going up $500 to $700 every year, because so much land in our area is being used for development. I hate to thjnk the price they would put on our land. PAGENO="0849" 83~ We have some river frontage and we are in close proximity to Mani- towoc, about 7 miles, and now they are going through with 1-43 which will take 40 acres per mile out of much of our township, so that extra added tax burden will be on us and that will increase the value of our land. If my husband died, we have debts. Besides paying the estate taxes, State and Federal, could I go and borrow money from the bank? No way, no way. Yet, I worked along- side of him all of these years and it would be for nothing. We have two sons. Mrs. KEYS. I think you have eloquently spoken the problem.. One further question along that line. Do you think it would be equitable to allow that different kind of evaluation, perhaps along with an increased exemption, as long as the farm were to continue to be farmed by the family, and if the decision for a period of time, say 10 to 15 years, if the decision were made by the heirs, say 3 years later, to sell for purposes of commercial development or anything, that at that time if the taxes based on fair market value be recaptured do you think that would be a reasonable way? Ms. VOGEL. Yes, I think it is a very good idea because we do want to keep this land in agricultural land. In order to do this we have to make it hard to take this land and do otherwise with it. Now, when you say stay in the family, we were wondering in this Burleson bill, too, if I would own the farm or if our sons would in- herit it could they own it and, rent it, to a son? Or could I, if I didn't have a son, rent it to someone other then my family and would it still be, in that election? These are some questions that we have been asking, and I have had a lawyer look this bill over and he is question- ing transfer. Mrs. KEYS. Well, there are certainly definitions we will have to deal with. Again, thank you for your excellent testimony. Thank you, Mr. Chairman, for your consideration in allowing me to use more than my 5 minutes. Mr. Bunr~ssoN. Mr. Steiger, do you have a question? Mr. S~r1~IGER. Mr. Chairman, I have no questions. I do join with Mrs. Keys and,all who have had a chance to listen to this panel, :in thanking you for making' the trip, particularly-and I obviously am biased-those three of you frow Manitowoc who did such an excellent job in their presentations. Thank you. Thank you, Mr. Chairman. Mr. BURLESON. Mr. Jacobs, do you have questions? Mr. JAcoBs. Well, I want to thank the panel also, and tell you that if all the members of the committee were not present to hear your excellent testimony, they, themselves, have testified eloquently to the kind of priorities that `are going on in Washington these days. I hope they will change. I mean the priorities, of course. Mr. BURLESON. Again it has been a pleasure, and with appreciation we thank all of you. Mr. Bock, I was intrigued, I would like to have a discussion with you on your recommendation to repeal the entire estate tax. As a matter of fact, I would be for it, but you reach for the impossible `here. Mr. BOCK. Excuse me? ` PAGENO="0850" 836 Mr. BtTRLESON. You don't always get those things that you want. Mr BooK It's certain you won't get them unless you ask for them Mr BTJRLESON I will say, Ms Lane, if we don't get this legislation passed I am going to be reading your articles more carefully to try to learn how to do that I don't have children but I have a little scraggily ranch out in west Texas, and I don't think my wife is going to view me with great favor if I am lying there and I haven't left a little something to her to keep the Government from taking it all Thank you again for coming We appreciate it very much Now, we have the last panel Mr Byron L Dorgan, commissioner, North Dakota Tax Department: Dennis Rasmussen, Nebraska State Senator, B Powell Harrison, Jr, president of the Piedmont, Va, Environmental Council, Young D Hence, secretary of the Maryland Department of Agriculture, and Gene Mullinix, chairman of the Mary land Workforce on Preservation of Farm Land We are pleased to have you, and we apologize for being so tardy in hearing you. It was unavoidable. I know, as experienced men in Government and other official positions, you understand Commis~ioner Dorgan, we will be glad to start with you STATEMENT OP BYRON L. DORGAN, COMMISSIONER, NORTH DAKOTA TAX DEPARTMENT Mr DORGAN I am an elected official in the State of North Dakota I am testifying in that capacity today I ~ou1d like to ask that I be allowed to summarize the testimony that I have submit~ted to you in written form and then be excused from the panel to meet another committee Mr. BrIRLESON. Your full statement will be included in the record. Mr. DORGAN. I am not an expert in the estate tax field, as were some of those whom I have heard testify today. I am an administrator and an economist, and I have some feelings about the economic philosophy and tax philosophy with respect to the estate tax I think it is important to try to separate as best we can fact from fiction when one tries to view the debate about estate taxes There is a great deal of debate and a lot of statements being presented and one must distinguish what is fact and what is hction As I read a bit abqut the Federai estate tax, I noticed that it has basically been a revenue raising measure first enacted in the Civil War to raise some money. A fellow named Pig Iron Kelly, a member of your committee in 1868, decided to abolish the entire IRS system and accepted as a compromise abolition of the estate tax Another fellow named Dinkley, became the father of our modern estate tax in 1898 That has been changed and rechanged In 1942 the basic exemptions that we now have were enacted and the basic rate stiucture that we now have was enacted So it is not surprising, that the estate tax sys tern today is regarded as a very weary, aged system that needs chang ing The fact that you have petitions over on the table submitted by the previous panel with over 100,000 signatures is witness to the fact that the American public is calling for a change When change is long overdue, the American public begins calling in many ways for a change PAGENO="0851" 837 Franklin Roosevelt, talked about the reason for an estate tax. He said: In the last analysis, great accumulations of wealth amount to a perpetuation of great undesirable concentration of control in a relatively few individuals over the employment and welfare of many, many others. Such inherited economic power is as inconsistent with the ideals of this generation as inherited political power was inconsistent with the ideals of the generation which established our Government? I think that strikes at the heart why we need an estate tax. It is certainly not to raise revenue for North Dakota as a State tax or the Federal Government as a national tax. It raises less than 2 percent of the Federal budget. There is a compelling reason to have an estate tax. I have always sort of viewed it as an antirevolution tax in a sense. History shows us that most societies inevitably had to have some sort of violent revolution to redistribute concentrated wealth at one time or another. This is sort of a new venture and new experiment in living in this country over the past couple hu~idred years. I think the estate tax is part of a safety relief valve to redistribute massive accumulations of wealth peacefully through~our tax system. The compelling reason to have an estate tax in the first instance is to redistribute money. If that is true going back to 1940, 1942, farmers, small businesses, and wage earners for that matter, who have accumu- lated a home in the case of wage earner, lifetime savings, or who have accumulated a small farm unit or moderately small business, were able to pass those assets on to heirs with very little interruption from an estate tax. In North Dakota you could easily have passed on a farm well over 1,000 acres in size with no tax ramifications at all. You could have passed on a relatively successful small business or easily a fine home plus a lifetime accumulation of savings for a wage earner with no estate tax ramifications at all. Times change and so must tax laws. Tax laws have not changed in the estate tax area. There is an inevitable certain effect in taxes that is called an unle~is1ated tax increase. I have talked a lot about that in North Dakota with respect to the income tax. Your income tax at the Federal level and ours at the State. The same principle applies in the estate tax. Those of us in political life, proudly proclaim to anyone within speaking distance, that we are opposed to tax increases. I have, and I suppose you have. Nonetheless, all of us, I think, know with the progressive tax system in the income tax and progressive ta~x rates in the estate tax that simply by doing nothing, inflation guarantees tax increases for every Ameri- can in the income tax and guarantees tax increases in the estate tax. One of the greatest deals politicians ever had in this country, is being opposed to all tax increases and yet by doing nothing, incorpo- rating tax increases in all income tax returns and all estate tax returns over time. Well, people are beginning to understand that. They might have money income increases over time, but no real income increases. That is, the median income might go from $8,000 to $10,000 in your area. Yet the buying power might remain exactly the same. The average accumulations of assets might go from $60,000 to $90,000. Yet the real value of that accumulation would remain the same. PAGENO="0852" 838 Yet, in both instances, relating to the income tax and estate tax, they would pay higher rates than they would have before. That is because of the way the progressive tax system in income and estate tax relates to a changing economy that is burdened with the kind of inflation this country has been burdened with. The point that the last panel made about farmland values is an im- portant point. The farmland values are very difficult to ascertain. I think that one should reasonably expect to be able to pass on a small- to moderate-size farm or accumulation of assets or small business without estate tax burden in this country. They could have in 1942 and they should be able to in 1976. The estate tax should break up accumulations of large concentrated wealth in this country and not disrupt the continuity of a small busi- ness or economic continuity of a small farm or disrupt the ability of a wage earner to pass on a modest accumulation of assets. We have an estate tax in North Dakota. We tend to try to follow Federal guidelines. North Dakota and other States are not likely to adopt a $200,000 Federal exemption-which I think would be appro- priate-unless the Federal does it. If the Federal does it, the States will very likely follow suit. I think the increase in the exemption to $200,000 would approximate the real money value of $60,000 in 1942. Coupled with that is the thought that we need to revise the rates in the middle and low asset accumulation range of the estate tax. If we don't revise those rates, then we will have, and we already have dis- torted significantly the incidence of taxation in the estate tax area. If you do look at those two areas, I think that the product of this com- mittee will bear fruit and satisfy the objections of many Americans who are submitting petitions~and I know writing and calling and send- ing telegrams to you. We have an unusual type of State that is one of the most rural States in the country. We rank 15th in per capita personal income. We have about 41,000 small farmers, with very, very few large accumulations of assets. Nonetheless, a reasonably prosperous State. The kind of State that we have, being a rural State and that rural structure that supports so many small towns and rural communities, it is disruptive when an estate tax enters into the economic continuity of that farm unit, forces the liquidation of part of it, for example, because that eliminates part of the support for those small rural areas, the small towns, and so on. It has widening repercussions. I am pleased that you are looking into this. I think it is a successful area to engage in tax reform, and I commend you for it. [The prepared statement follo~is:] STATEMENT OF BYRON L. DOROAN,, STATE TAX CoMMIssIoxun, STATE OF NORTH DAKOTA The American public has begun sending loud messages to the United States Congress and the state legislatures that there needs desperately to be some changes made in our estate or death tax laws. The American public is right. The estate tax is weary with age and no longer relates successfully to today's economy with its exemptions and rates. I'm pleased that Congress is holding hearings on this subject and I have been told that this particular hearing before the House Ways and Means Committee relates to the general subject `of estate tax reform and does not necessarily focus on any `one particular piece of proposed legisla- tion. Therefore I will attempt to make some broad philosophical observations about the estate tax system and the changes in it which I believe are necessary. PAGENO="0853" 839 Some years ago when I was studying economics and more specifically, the field of `taxation, I perceive that the estate or death tax system in this country was part of a grand plan in the American system to redistribute wealth. Idealistically, I thought the estate tax was an "anti-revolution tax." Basic history lessons tell us that many other societies in the world have invariably had to experience violent revolutions in order to redistribute wealth when that wealth became concentrated in the hands of a few. It appeared to me that the United States, through a system of taxing transfers of estates, was engaging in a method of redistributing concentrations of wealth peacefully through our tax system. Philosophically, that has made a lot of sense to me. In 1935 President Roosevelt emphasized the relationship of the federal estate tax system to this concept of redistribution of wealth. According to Roosevelt: "The desire to provide security for one's self and one's family is natural and wholesome but it is adequately served by a reasonable inheritance. Great accumu- lations of wealth cannot be justified on the basis of personal and family security. In the last analysis such accumulations amount to a perpetuation of great and undersirable concentration of control in a relatively few individuals over the employment and welfare of many, many others. Such inherited economic power is as inconsistent with the ideals of this generation as inherited political power was `inconsistent with the ideals of the generation which established our government. Notwithstanding these reflective thoughts expressed by President Roosevelt, I found, as I researched the origins of the estate tax prior to this hearing, that the redistribution of wealth effect was only a by-product `of the major reason for the initial imposition of estate taxes. In fact, estate taxes historically have been imposed and increased in order to finance the war efforts by this country. For example in 1862 the first estate tax was enacted in order to help defray the cost of the Civil War. In 1870, however, a distinguished member of the House Ways and Means Committee named "Pig Iron" Kèlley led the charge to abolish the estate tax. Actually, he proposed to abolish `the Internal Revenue Service completely, but had to accept the death of the estate tax as a consolation prize. For the next 28 years the United State~s government had no federal estate tax. In 1898 another House Way and Means Committee member named Representa- tive Dingley proposed an estate tax ranging to 15% to help finance the Spanish American War. Again in 1917, the estate tax rates were raised to a maximum of 25% to help finance the First World War. There have been a lot of minor changes in between, bu't in 1942 during the Second World War the estate tax rates were fixed from 3% to 77% and the estate exemption was raised to $60,000. That is essentially the same estate tax that the American public now lives and dies with in 1976. As an antiquated tax, it doesn't reflect today's needs and realities, `and it needs desperately to be changed. Even though the history of the estate tax shows that it has been primarily a revenue measure during times of national crises, the estate tax is still well grounded philosophically and can operate as a pressure relief valve to redistribute wealth through an orderly process in our society. We need an estate tax in this country that will prevent the transmission from generation to generation of vast fortunes by will, inheritance or gift because such a transmission of concentrated wealth is inconsistent with the ideals of the American people. But at be same time, we do not want an estate tax to behave as a punitive tax that destroys the average family's ability to retain a small family farm or business. We do not want an estate tax that destroys the con- tinuity of the economic unit owned by persons of modest means who would like to pass that heritage to either their spouse or lineal descendents. Times change and so should tax laws. Unless tax laws change with the times, that which is transcendentally true can become existentially false. A good example of this principle is the $60,000 basic exemption in the federal estate tax system. In 1942 that exemption would have allowed the transfer of a farm with well over 1000 acres without any estate tax obligation. At that time, the size of the average farm in this country was far below 1000 acres. Today, for example, in North Dakota the size of the average family farm is slightly over 1000 acres and yet at today's prices the transfer of that family farming unit can and does incur a substantial estate tax obligation. The same principle is true `with the moderately successful small business or in the wage earner's case, a home and lifetime accumulation of savings or assets. In 1942 all of these could be passed on to the spouse or to a lineal descendant without estate tax liability. However, because the tax law has not changed with the times and because we have had unprecedented economic changes, particularly inflationary 68-872 0 - 76 - 55 PAGENO="0854" 840 price level changes, now the average family farm cannot be transferred without a substantial estate tax obligation. Nor can a small business or a moderate accumulation of assets by a wage earner be transferred without an estate tax obligation. We need to increase the estate tax exemption In our `federal estate tax system in order to reflect today's economic `standards. A $200,000 basic estate tax exemption that has been widely proposed is proper for all estates of farmers, businessmen and wage earners. This would not be any substantial departure from past policy, since it would approximate and be relative to the estate tax enacted in this country in the 1940's. In addition to increasing the basic exemption from $60,000 to $200,000, I believe that we have to study and change the estate tax rates, particularly in the low and middle sized estates. The rate structure, like the exemption, must change with the times or it too will effect an unplanned change in the incidence of taxation. For example, if in 1942 a family estate had a taxable estate tax base of $30,000 that family would have paid $3,000 in estate tax or an effective taxable estate tax rate of 10%. If, as a result of price level increases and the decline of pur- chasing power of the dollar due to prolonged periods of inflation, a head of ~ a family of today leaves a taxable estate of $100,000, then the estate tax would be $20,000 of 20% of the taxable estate. Although the average family unit has the same purchasing power relative to all other families in our society, it Is now paying an estate tax that is several times higher than the estate tax paid by the average family 30 years ago. While the real money value of the estate might have remained approximately the same, inflation has pushed the inflated market value of the estate upward over time and pushed that estate into a higher tax bracket. This is a hypothetical case that I have used to Illustrate the effective inflation on the incidence of the estate tax itself. While I intensely dislike foot- ball analogies in these instances, there is one that seems most appropriate here. The dollar, much like the football, is moving in value. The down markers (in this case the estate tax rates) must be moved also in order to maintain an accurate measurement at any given point in time. North Dakota is one of the most rural states in America. It is also a state with a relatively high per capita income (we rank 15th in the nation) and our economy, while very healthy, resembles Adam Smith's description of early England, when he pictorialized the intermingling of small agricultural units amid a nation of shopkeepers. We have about 42,000 farms in North Dakota that support a large number of small towns and a lot of small merchants. We have a law in North Dakota prohibiting corporate farming and therefore the farms in North Dakota are family owned and operated and still maintain a base of support for small towns which are the hubs of economic activity for rural living. There are not many large estates that show massive accumulations of wealth in North Dakota. Most estates reflect the accumulation of the assets of a small farm, small bu'siness, or a wage earner's investments over a lifetime. In 1942 most of these accumulations would have `been allowed to pass to descend- ants without economic interruption. Because the estate tax `law has not kept pace with changing times, these estates and the economic units they represent are now being interrupted by an estate tax. Philosophically I believe North Dakotans support the notion that an estate tax or inheritance tax could and should be used to fragment the immense collec- tion of wealth over long periods of time in this country. However, North Dakotans feel equally strongly that the estate tax should not Interrupt the continuity of the individual family units that make up our type of economy and should not impede the ability of average Americans to pass a modest accumula- tion of assets to their heirs without burdensome estate taxes. I believe that we need a fresh, new approach to taxing estates and I'm pleased that your committee is beginning comprehensive hearings on this subject. I hope that as a starting point you will consider increasing the exemption to $200,000 and making some basic rate changes in the lower to middle areas of the estate tax rate range. Finally, as a state tax official, I can tell you that a number of states are studying the idea of following federal exemptions with respect to the state estate taxes. In fact, in an effort to simplify the estate tax law in our state, North Dakota now has a $60,000 estate tax exemption which matches the federal exemption. North Dakota has a federalized estate tax law, whereby our North Dakota tax rates are applied to the North Dakota portion of the federal taxable PAGENO="0855" 841 estate. I'm confident that If the federal government will increase Its exemption in the estate tax, that North Dakoa and other states will respond by Increasing their exemption in like manner, Mr. BURLESON. Thank you very much, commissioner, for your analytical statement. Senator Rasmussen, we will be glad to hear you. STATEMENT OF RON. DENNIS RASMUSSEN, NEBRASKA STATE SENATOR Mr. RASMUSSEN. I assure you at this time of the day my testimony will be as brief as I can make it. After listening most of the day, actually nearly all the technical points have been covered, I would certainly summarize as quickly as possible. I would ssk you to put my testimony in the record. Mr. BURLESON. Your full statement will be included in the record. Mr. RASMUSSEN. I am an active farmer-rancher and also, of course, a concerned citizen, and I am also representing the Legislature of the State of Nebraska, and I represent the 41st district which is the central part of the State. I represent one of the more rural districts in an all-agricultural State. In Nebraska we have not had any real serious problems yet in corpo- rate interests buying out family farms; they are just starting showing up, but we are seeing dramatic changes in the family farm. For a minute or two I would like to illustrate what is happening. I think we tend to accumulate capital through our life while we are sacrificing short-term income. I think, in other words, most of us that till the soil sacrifice most of our lives in order to end up dying as a man with some wealth. Normally a farmer in order to increase his income has had to pur- chase additional property which will allow us to utilize the economic sizes associated with our operations. I think the University of Nebraska probably in a nutshell had it in 1972, a 480-acre farm in eastern Nebraska would require a $250,000 property. That was in 1972. Today it would be $350,000 or $400,000. We can go all the way from a small farm to what is considered a large ranch operation in 1972. To come up with the average income in the State of Nebraska, which was roughly $14,000, he would have to have an accumulation of property and land in excess of $1.7 million. Now that is a lot of money, and it is a lot of property, but that is what the study came up with. The trend is clear, farms are getting larger and less numerous. In my instance I have a son. We do not have a large operation. In 1967 through a competent attorney we did incorporate what we con- sider our homeland into a corporation, and he had the foresight at that time to see what was happening. In that respect we were lucky. The many people who have contacted me have not been quite that fortunate. We will talk about these cow-calf ranches, or wheat. *This comes in where we are pretty apt to require sale to satisfy tax liability. Yet these total operations have a heck of a lot of capital to produce a moderate income. In conclusion, the capital required to operate a farm is tremendous. Any type of farm capable of producing a $14,000 income in Nebraska PAGENO="0856" 842 will have a capital outlay of at least $300,000, and in some cases like my Sandhill County that I represe~t, anywhere from $1 to $2 million. This, of course, would show that a $200,000 estate is not substantial by Nebraska standards, and certainly I think it would carry through in many of our other States. I think there is one thing that should be brought out, and this is not simply an agricultural problem. Inflation has caused the same problem for any family business, I don't care whether it is the lumber- yard or grocery store. This morning testimony was brought out about stocks and bonds. Well, there is one area that, if you have your investment in stocks and bonds, there is a chance to liquidate part of those off, dribble them off to cut down. I assure you in a family-size operation it is impractical and im- possible to dribble off a few acres at a time or quarter section of land in order to take care of your tax obligation because it then, in essence, makes your operation inefficient. * Inflation, I certainly think, has been the culprit in making our $60,000 exemption very insignificant. I think when compared with the assets of many self-employed people hopefully this dollar figure can be raised and, of course, this is in your committee's wisdom and of course the rest of the Members of Congress. I think the amount should be raised to help those who have worked a lifetime to help their children carry on a family business. As a mem- ber of the legislature in January we did report out a resolution that was sent to our congressional delegation. This resolution passed 40 to nothing. There was nine not voting. We have a 49-membership in the Senate. I think the thing was that we received support from all ele- ments in our body. They are rural and urban, what we consider liberal and Conservative and Democrat and Republican. Not one member voted against our resolution. There was no opposition. I think, if a diverse body like this can see the need for both farmers and consumers to preserve the family-owned farm, and as I said the small business, myself, and the legislature realized that one of the major causes of destruction in our family farms and small businesses is the Federal inheritance and estate tax laws. This resolution was sent back here, and with that, Mr. Chairman, I certainly thank you for your time and would certainly hope that you would act favorably to bring something out from your committee that will help the people not only in my State of Nebraska, but the Nation as a whole. Thank you. [The prepared statement follows:] STATEMENT OF DENNIS L. RASMUSSEN, STATE SENATOR OF NEBRASKA Testifying *as a farmer-rancher and concerned citizen who is interested in the preservation of the family farm. I first became interested in the problems of our estate taxation system when I introduced a bill in our State Legislature to give some relief from our state inheritance tax laws. I soon learned how difficult this is because of the credit the federal estate tax law gives for state death taxes paid. This made it extremely difficult to give relief to the taxpayer. Rather, this original bill would have simply apportioned the total tax bill differently. We have revised the bill considerably, and currently the bill has been advanced from committee and is waiting for action on the floor. The net effect of the revised PAGENO="0857" 843 bill is still to elir uate the estate tax on a $300,000 estate, and put that money back In the hand Ot the heirs. As we wor~ect ~n this bill, I gained considerable knowledge about the federal estate tax Ia ys, and began to realize that most of the problem results from the federal law failing to keep pace with inflation, especially in land values. If we are really serious about maintaining the family farm, we must have help at the federal level. There is not much a state can do, even if they are disposed to do' so. I represent one of the more rural legislative districts in an agricultural state. In Nebraska, we have not had a serious problem in corporate interests buying out family farms, but we are seeing a dramatic change in the family farm. Let me illustrate what is happening to Nebraksa farm families. The current trend of family farm agriculture is to accumulate capital while sacrificing short-term income. In other words, farmers sacrifice most of their lives in o1~der to have an estate of some value at death. Normally, a farmer will, in order to increase his income, purchase additional real property which will allow him to utilize the economics of size associated with agriculture. A 1967 study of farms in eastern Nebraska showed that the average capital investment was $213,310. By 1972, the capital investment was $311,740. Capital inputs, including land, accounted for 45% of all ~tgrieultural inputs used in farm production in 1940, but climbed to 80% in 1972, and is projected to reach 90% by 1980. The University of Nebraska made a study in 1972, which showed the amount of capital required for a farmer to produce approximately $14,000 per year income (Range ± $1,024). The following are the results: Type of farm Acres Capital Swine, corn, eastern Nebraska Grade A dairy, corn, eastern Nebraska Beef feeding, corn, eastern Nebraska Irrigated corn, beef cowhead central Nebraska Wheat Fallow, wheat farm, western Nebraska Cow-calf ranch, northern Nebraska 480 400 480 640 6, 000 22, 000 $250, 000 275, 000 425, 000 570, 000 760, 000 1, 765, 000 At least in the case of ranch land, the value of the land has doubled since 1972 (when this study was made). The study allowed $50 per acre; in 1976, several areas of sandhils pasture sold for $100 per acre or more. The trend is clear; farms are getting larger and less numerous in Nebraska. One may also conclude that the total acreage or capital investment is not a good indicator of the potential net income to the farmer. The cow-calf ranch, the fallow-wheat farm, and irrigated corn-beef herd are most likely to require sale to satisfy tax liability, yet they must have sub- stantially larger capital to produce a moderate income. In conclusion, the capital required to operate a farm is substantial. Any type of farm capable of producing a $14,000 income probably will have capital of more than $300,000, (in some cases perhaps between $1 and $2 million more). Clearly, a $300,000 estate is not substantial by Nebraska standards. This is not simply an agricultural problem, however. Inflation has caused the same problem for a family business which carries an inventory or has capital assets. Examples of these include a grain elevator, grocery store, and lumber yard. Inflation has made the current $60,000 exemption, which was established in 1943, very insignificant when compared with the assets of many self-employed people. Hopefully, this dollar figure can be raised to an amount helpful to those who have worked a lifetime to help their children carry on the family business. As a member of the Nebraska's Legislature, I can also report to you that the body, voting 40-0-9, passed a resolution urging the Congress to take action on the federal estate tax laws so that the states may pass legislation to help save the family farm. The measure received support from all elements of our Legislature, both rural and urban; liberal and conservative; Democrat and Republican. Not one member voted in opposition; all of our diverse body can see the need, both for farmers and consumers, to preserve the family owned farm and small business. PAGENO="0858" 844 The Legislature realized that one of the major causes of destruction of the family farm system in the federal inheritance and estate tax laws. The resolution is strongly worded, an indication of the strong feelings *the body had on the matter. LEGISLATURE OF NEBRASKA EIGHTYFOURTH LEGISLATURE SECOND SEssION (Legislative Resolution 116) Introduced by DeCamp, 40th District. WHEREAS, the salvation of the family farm in the State of Nebraska and the United States is of critical importance to both agriculture and the consumer in America; and WHEREAS, one of the major causes of destruction of the family farm and the family farm system is the loss of family owned farms and business because of federal inheritance and estate tax laws; and WHEREAS, it is to the benefit of this country to have estate tax laws that are not confiscatory in nature which present federal estate tax laws are; and WHEREAS, the Congress of the United States has seemingly procrastinated on this most important matter thereby making It impossible for state legislatures to effect or enact corrective legislation until the federal government acts. NOW, THEREFORE, BE IT RESOLVED BY THE MEMBERS OF THE EIGHTY-FOURTH LEGISLATURE OF NEBRASKA, SECOND SESSION: 1. That the Legislature of the State of Nebraska exhorts and insists that the Congress of the United States take action on this matter of the federal estate tax laws immediately in order that state legislatures throughout the United States may take action yet this year which will help save the fanilly farm. 2. That a copy of this resolution be sent by the Clerk of the Legislature to all members of the Congress of the United States and the Nebraska's Congressional delegation be encouraged in the strongest manner poEFible to utilize whatever abilities they have to bring this matter to a satisfactory conclusion as quickly as possible. GERALD P. WHELAN, Pre8idei~t of the Legislature. I, Vincent D. Brown, hereby certify that the foregoing is a true and correct copy of Legislative Resolution 116, which was passed by ~he Legislature of Nebraska in Eighty-fourth Legislature, Second Session, on the 3rd Day of February, 1976. VINCENT D. BROWN, Clerk of the Legislature. PAGENO="0859" Neb 845 Legislature AMP I ~ AYE I NAY INOT v6Tiüil I 40 1 0 0 ROLL CALL #~kt. .DATE .7~3 814th LEGISLATURS Mr. BURLRSON. Thank you, Senator. I know we couldn't expect it to be done as easily as you have done it in the State legislature. hut I hope we will be able to do something. Mr. Harrison. STATEMENT OP B. POWELL HARRISON, 1R., PIEDMONT (VA.) ilVIRONMENTAL COUNCIL Mr. HARRISON. Thank you very much for your patience today, and that of your colleagues. And I appreciate this opportunity. I have submitted my statement in writing. I trust it will be in the record. `II MV 11 ..IFcw].nr - PAGENO="0860" 846 In the interest of time here I am going to try to highlight two or three things. Mr. BuRLESON. Your full statement will be included. Mr. HARRISON. I live in Leesburg, Va., which is not too far from here. I am a little country businessman and have dealt with farmers most of my life. I have an abiding affection and respect for them. I am here today principally iii behalf of the farmer, as it were I am chairman of the board of the Piedmont Environment Coun- cil, which council covers nine counties of the Piedmont area of Vir- ginia. We were organized about 3 years ago for the purpose of trying to presei~ve. the historic character of the countryside. That was a broad objective. Immediately we felt that the most important thing that had to be done, if we were going to succeed in that, was to preserve farming as a viable industry. That is what got us into this field. Since then we have had a farm study committee. We now come to conclude that perhaps the most important thing we have to do now as far as Vir- ginia is concerned is to get a change in the Federal estate tax. We have considered this extremely important. because at stake is the. issue of food supplies for the future and low prices for food in the city super- markets, which I don't think many peoi)le have understood, and the well-being of the agricultural industry throughout our area on which many communities are very much dependent. 1/\Tithout, question-and this is the point. I want. to make-the farm- ing industry in my legion is nearing collapse. It. is my impression that this really is true t.hroughont much of the east. Agriculturally speaking, we are about where Penmi Central was 6 months l)efOre the blowup, or where New York City was shortly before, the bailout.. It is just that serious. I don't think it is generally recognized it is that bad yet. A few facts I might mention here real quickly will indicate that. One, the age situation. The median age of our Piedmont population is 26 to 27; the median age. for those in the labor force for all employ- ment in the region is in the group 25 to 34. But the. average age of farmers in the. region is 55, with a sigimificant portion over 65. Econ- omists gene.raily feel that Once the. age structure, of an industry reaches this state the industry "has one foot in the grave." Two, new business. No new bona fide. farming enterprises have, been started in nearly half .of our coimties for 3 years. Contrariwise, as each old farmer dies, and most are old, his farm is generally sold t.o spec- ulators in Ordler to pay thie Federal est.ate tax. I know of no case in the history of this country where an industry has survived this condition of systematically closing up shop. Three, risk capital. Like other American enterprises, farming has evolved into a sophisticated. mechanized operation, where. today a 400-acre farmer may have as much as $175,000 invested in machinery, buildings, and herd, exclusive, of land. The. land would add $160,000 more at. "use value." or $800,000 at. "market. highest. use" value. Yet with this tremendous capital outlay this farmer probably derives au income. of only `$20,000 net if he is a good dairy farmerS only $9,000 net if he is an exceptional livestock farmer, and $1i~000 net if he is a good grain pi~oduc.er with `all 400 acres in produc.tiomi. Few of t.he farmers we deal with can do this well. PAGENO="0861" 847 Do you know of any other business where one individual will have so much capital at risk with so little return? Yet this is the man on whom we have saddled the biggest and most impossible tax burden. Now let's turn to what happens to the 400-acre farmer at his death. He has $800,000 in land at speculative nonfarm value and $175,000 in machinery, buildings, and herd. Add his personal property and some few investments, and his worth to the IRS is easily $1 million. Thus his Federal estate tax is levied at about $320,000. Where, oh where, does his family get this kind of money? Only `by dismantling the farm. He sells the herd first, machinery next, and then the farm goes to a specula- tor because he is the only `man who can afford to pay $800,000 for it. This is `always what happens. We estimate that 20 percent to 30 percent o'f the once productive farmland of Loudoun and Fauquier Counties of Virginia are now in the "a'bandoned" derelict category. Drive around `the countryside and view them. Once productive farms become derelict land, with honey- suckle and cedars taking over the fields `and the buildings and fences slowly rotting. Monuments to our inability to keep farming healthy. For 200 years a large percentage of the farms in this region have been operated and owned `by the same families. It has been a way of life, a distinct culture with a flavor of independence that has been thoroughly recognized. But in. the last 20 years the massive spreading of population from the inner cities has engulfed large agricultural regions and created a speculative land `boom that has had peculiar ad- verse affects on `taxation. `These affects are destroying profitable f arm- ing, a foul feat that depressions and wars have been unable to do be- fore. They must be altered quickly. The need to change our taxes from being based on market value to use value as regards both property tax and estate tax. Virginia has done its part. Over 2 years ago the `more strained counties adopted the land use assessment property tax for farmers. Now 23 counties have adopted it. The most essential action required today to keep a farming industry alive in Eastern United States is to adjust the Federal estate tax for the farmer so that it too is based on land use evaluation. My organization recommends that the basic exemption be increased from $60,000 to $200,000, and the land use assessmenj be adopted for the overall evaluation of a- deceased farmer's land. Merely to in- crease the exemption as some are advocating is to ignore the basic problem, in my opinion. It does not get around to the speculative evalua'tion that the farmer is tagged with on his land over which he has no control aM he has had nothing to do with. A good farm friend of mine remarked the other day, "My farm is free and clear. But when I die, for my wife to continue to live there and my sons to continue farming it, they will have to pay the Federal Government a first mortgage of impossible size. I don't know what they will do." - My farm study committee feels that the most insidious fo'rce at work in the farm picture today is the imposition of the Federal estate tax based on speculative urban land values. The farmer feels helpless in the face of it. It kicks the widow ou't of her home, which frequently has `been in the family for generations. It prohibfts his sons from con- PAGENO="0862" 848 tinning in the family bnsiness. It destroys our essential food source. It ruins an old and revered cultura It destroys the beauty of the landscape while wasting the land. And it fouls up the environment. What more can I say? Thank you, sir. [ The prepared statement follows ] STATEMENT OF B. POWELL HARRISON, JR., PIEDMONT ENVIRONMENTAL COUNCIL (VIRGINIA) My name is B Powell Harrison Jr I live at Leesburg Virginia where my family has been living for generations. Although not a farmer myself, I am a country businessman who has always done business with farmers and have an abiding affection and respect for them. My remarks this morning will be based on my experience in the Northern Piedmont region of Virginia, which comprises 9 counties, from Albermarle with Charlottesville as its county-seat North to the Potomac River at Loudoun, County, with Leesburg as its county-seat. Perhaps most of you know the area and have understood that since colonial times it has been one of the most productive farming areas in Virginia. It Is also known for its scenic beauty, and history, having produced Jefferson, Madison & Monroe, men we are honoring this Bicentennial year. The past may be glorious. But the present is chaotic; the future dark indeed unless government at all levels takes a firm studied fearless hand. Three years ago a group of about 40 citizens concerned over the deteriora tion of the character of this magnificent countryside decided to organize the Piedmont Ehvironmental Council of which I am Chairman of the Board We have a professional staff of 5, now being expanded to 8. The board objective of PEC is to save the historic character of the Piedmont region. This was finally distilled into two fundamental fields of action. The first is to ~ave farming. The job is too massive just to peck away at saving individual sites, and we felt that neither open space nor the character of the countryside can be conserved unless we can save farming as an industry The second objective is to preserve the distinctive characteristics of the nine county seats so they will properly reflect their 200 years of serving rural communities. It is this business of maintaining a viable farming industry that we are dis- cussing today There is no more important issue before the Congress in my judg ment than putting a halt to the systematic reduction of farming in which the federal government is now engaged Why so important'? Because at stake in the issue are the food supplies for the future; low food prices at the city supermarkets; ~ind the economic well being of the agricultural industry on which so many communities and states are highly dependent ; `deep concerns of every American family. Without question, the farming industry in my region is nearing collapse. It is my impression~that this is true throughout the East Coast. It may be true na- tionally. Agriculturally speaking, we are about where Penn Central was six months before the blow-up; or where New York City was shortly before the bail-out. A few facts may be helpful here (1) Age The median age of our Piedmont population is 26-27 The median age for those in the labor force for all employment in the region m in the group 25-34 But the average age of farmers in the region is 55 with a sigmficant por tion over 65 Economists generally feel that once the age structure of an industry reaches this state the industry has one foot in the grave (2) New business No new bonafide farming enterprises have been started in nearly half of our counties for 3 years Contrariwise as each old farmer dies and most are old, his 1~arm is generally sOld to speculators in order to pay the Fed- eral Estate Tax I know of no case in the history of this country where an In dustry has survived this condition of systematically closing up shop (3) Risk Capital Like other American enterprises farming has evolved into a sophisticated mechanized operation where toc~ay a 400-acre farmer may have as much as $175 000 invested in machinery buildings and herd exclusive of land The land would add $160 000 more at use value or $800 000 at market highest use value Yet with this tremendous capital outlay this farmer probably derives an income of only $20 000 net if he is a good dairy farmer only $9 000 net if he is PAGENO="0863" 849 an exceptional livestock farmer and $11,000 net if he is a good grain producer with all 400 acres in production. Few of the farmers we deal with can do this well. Do you know of any other business where one individual will have so much capital at risk with so little return? Yet this is the man on whom we have saddled the biggest and most impossible tax burden. Now let us turn to what happens to the 400-acre farmer at' his death. He has $800,000 in land at speculative non-farm value and $175,000 In machinery, build- ings and herd. Add his personal property and some few investments, and his worth to the IRS is easily $1,000,000. Thus, his Federal Estate Tax is levied at about $320,000. Where, oh where, does his family get this kind of money? Only by dismantling the farm. He sells the herd first, machinery next, and then the farm goes to a speculator, because it's worth $800,000 to him, or he thinks so; it's worth only $160,000 as a farm. So, another farm is forced out of business by the Federal Estate Tax. The speculator-owner now waits five, ten, or fifteen years until he can sell for some other-than-farm use that will bring him a profit. The nation has lost more of its food base. Farms once lost never return. And the cost of food at the stores goes up again as the more precious food must come from greater distances. We estimate that 20% to 30% of the once productive farm land of Loudoun and Fauquier counties Virginia are now in the "abandoned" derelict category. Drive around the countryside and view them. Once productive farms become derelict land with honeysuckle and cedars taking over the fields and the buildings and fences slowly rotting. Monuments to our inability to keep farming healthy. For two hundred years a large percentage of the farms in this region have been operated and owned by the same families. It has been a way of life, a distinct culture with a flavor of independence that has been thoroughly recognized. But In the last twenty years the massive spreading of population from the inner cues has engulfed large agricultural regions and created a speculative land boom that has had peculiar adverse effects on taxation. These affects are destroy- ing profitable farming, a foul feat that depressions and wars have been unable to do before. They must be altered quickly. The need is to change our taxes from being based on market value to use value as regards both property tax and estate tax. Virginia has done its part. Over two years ago the more strained counties adopted the Land-Use assessment property tax for farmers. Now 23 counties have adopted it. The most essential action required today to keep a farming industry alive in eastern United States is to adjust the Federal Estate Tax for the farmer so that it too is based on "land-use" evaluation. The question I pose is this: Does the Federal Government not want Virginia farms to continue in farming at the farmer's death? Under present conditions the government precludes it. My organization recommends that the basic exemption be increased from $60,000 to $200,000, and the "land-use" assessment be adopted for the overall evaluation of a deceased farmer's land. Merely to increase the exemption as some are advocating Is to ignore the basic problem. Few farms will be saved due to the inadequacy of the exemption only. For instance, a 400-acre farm is not a big one as farms go today. Yet with an Estate Tax of $320,000, how can a $150,000 exemption keep the enterprise going? It cannot. The family still cannot raise the remaining $170,000. A good farm friend of mine remarked the other day, "My farm is free and clear. But when I die, for my wife to continue to live there and my sons. to con- tinue farming it, they will have to pay the Federal Government a first mortgage of impossible size. I don't know what they'll do." My Farm Study Committee feels that the most insidious force at work in the farm picture today is the imposition of the Federal Estate Tax based on specula- tive urban land values, The farmer feels helpless in the face of it. It kicks the widow out of her home, which frequently has been in the family for generations. It prohibits his sons from continuing in the family business. It destroys our essential food source. It ruins an old and revered culture~ It destroys the beauty of the landscape while wasting the land. And, it fouls up the environment. What more can I say? I trust you can correct this abominable situation. So much of our future depends on it. PAGENO="0864" 850 Mr. BURLESON. Thank you, Mr. Harrison. You do have a beautiful part of the country. I can understand your feeling for it. Mr. Hance, you may proceed. STATEMENT OP YOUNG D. HANCE, SECRETARY, MARYLAND DEPARTMENT OP AGRICULTURE Mr. HANOE. I have been here since 9:30 this morning. I recognize that you and other members of the committee have been here too. I thank Mr. Jacobs for his patience in hearing the last of this. I shall be very brief. I have heard many of the things I would have said to you per- sonally. I would only remind you that the future of agriculture really rests in the hands of this committee in their upcoming decisions. I hope that the committee members that have not had an opportunity to hear, for instance, the women's panel present their views and other views that were presented here today, will take the opportunity of learning some of the facts that will have presented to you and be able to under- stand the situation today. We in Maryland have approached, or are attempting to approach, a method or means of preserving agriculture. There has been a study going on since 1973. Legislation was introduced a year ago. A sub- committee in the legislature has been working all summer to produce legislation that can be acceptable. It is now in the general assembly. It is far beyond me to be able to predict what will happen, but in Mary- land the legislature is recognizing the need to preserve agriculture land. There is nothing that I can think of that would hinder it more than the present structure within the estate tax that would cripple any program that we may come up with in Maryland or in any other State. I think the committee recognizes the importance of agriculture. I think it is important that they recognize rural `development and the importance of the rural community `and if they consider these factors in making their decision as far as future adjustments in the estate tax, I think then agriculture can look to a bright future. Mr. Chairman, I respectfully urge the committee's consideration for these `changes. T'hank you, sir. I `have submitted a written statement. I `hope you will look at it. Mr. B1JRLESON. Your statement will be included in the `record. I assure you th'at it is appreciated. Your two Senators and two Members of the House from Maryland appeared before this committee this morning and very, very force- fully testified. It is appreciated. [The prepared statement follows:] STATEMENT OF YOUNG D. HANCE, SECRETARY, MARYLAND DEPARTMENT OF AGRICULTURE Mr. Chairman, my name is Young D. Hance. I am the Maryland Secretary of Agriculture and my office is located in Annapolis. I am responsible for all mat- ters relating `to the fostering, protection, and development of the agricultural interests of the State and, very clearly, some action is needed to correct the severe problems which have existed in the agricultural community for too long. PAGENO="0865" 851 Since the turn of the century many new words and phrases have sprung into existence; "Megalopolis" is one of these words which is heard time and time again as population boom's and development threatens to swallow land through- out the United States. Maryland is no exception to this trend, and all sectors of `the population have expressed alarm over t'he encroaching influence of urban and suburban development in this `State. Of particular concern is the status of agriculture and of the farmer in our increasingly metropolitan society. Certain trends are apparent upon examination of the statistics relating to agricultural land in this State. There has been a marked decrease in acres of agricultural land in Maryland, accompanied by a decrease in the percentage of land in farms, while a general increase has been noted in the average size of farms, the acreage `of irrigated land, and `the average farm value of land and buildings per acre. Projections of the Preservation of Agricultural Laud Committee in'dicate that by the year 2000, just 24 years away, the total land In the State in farms will approxImate 1.0 to 1.3 million acres, or 19.6 percent of the Staet area, a highly significant decrease from the 67 percent in 1945. It has been conjectured that the rapidly increasing value of farmland per acre is a major factor in the decrease of farm acreage; in fact, projections demonstrate `that should the trend continue, the agricultural land value per acre will approach $1,550 per acre `by the year 2000, as `compared to a cost of $640 `per acre in 1969, disregarding the impact of inflation. The farmer, par- ticularly the small farmer, cannot help being tempted .`by the profits `to be made by the sale of his land, especially when he is struggling to merely keep his head above wa'ter. In addition, the cost of argicultural land is far less than the cost of suburban land; hence, developers find it economically expedient to pu'rsue a leapfrog pattern of development and to purchase the less expensive farmlands. These are direct causes `for conversion of agricultural land. Less direct are such factors as the lure of the country, particularly for `higher income families (not only from this Sta'te, but from the entire Nation), speculation in real estate, the dearth of many `modern services and conveniences in agricultural areas, and the low income of the majority of those involved in farming activities. There is at present a bill to preserve agricultural land which has `been intro- duced into `the Maryland General Assembly. While it is prema'ture for me or anyone at this point to predict the outcome of this legislation, it is clear that the objectives of this bill would be seriously weakened by the provisions of the present Federal Estate lq~isl~tlon. `One `of the `significant fhctOth which has caused' land to be lost to agricultural use has been the severe and unrealistic Federal Estate Tax. The Federal Govern- ment's estate `tax became `a permanent part of `the Federal revenue system in 1916. At tha't time, the Federal tax included a $50,000 exemption and taxation rates from `one percent to 10 percent. The current law which was established in 1941-1942 and amended In 1954 provides for a $60,000 exemption with marginal rates of `taxation va'rying from 3 percent to 77 percent. This means that a decedent's farmland estate is assessed at its market value, rather than `being as- sessed for its value to agriculture and :has resulted in the heirs having few liquid assets with which to pay `the estate `taxes. The heir is `often forced to sell a por- tion or all of the land in order to pay `the estate taxes. More oftern than not, the `sale i's made to developers in lieu of `other farmers. I know a farmer who is 59 years old, drives an eight-year-old Chevrolet with 110,000 miles on it and lives in `an ordinary farm house. If anyone called him rich, I am sure he would laugh. But, if he died, his wife would have to pay $32,000 in Federal Estate Taxes. The reason, of course, is that their `modest farm has quadrupled in value since they bought it, thank's to inflation and `spiraling land prices. In other words, they have becom,e "paper rich." This example is typical for farmers not only in Maryland, but all over the country. I h'ad contact recently with a farmer In Frederick County-he an'd his wife are eighty years `old. They own about 300 `acres of laud and they `would like to see `their children eo~tinue in farming, but under `the present Federal Estate Tax, they will owe the Federal Government $200,000, ~and there is no way the heirs can meet this debt except to sell two- thirds of `the land. The inflated land prices that have caused dea'th taxes' to become a problem are also keeping young people from enteri'ng farming. It now takes at least $250,000 by many estimates for `a young man to enter farming, with high `equipment prices added to high land prices. Therefore, as you can `see, the farmer as our PAGENO="0866" 852 fathers knew him is a rare and endangered species. If our concern for this trend were purely a matter of nostalgia, a wistful return to a past of which there is no return, we could dispose of the subject with a few sentimental lines. But farm- ing fifty years ago was not that glamorous. Its satisfactions land rewards, of which there were many, were earned by the sweat of the brow. The burden of labor and certain kinds of deprivation, cultural as well as physical, fell heavily on the wonienfolk and the children. Incidentally, on this point, many farm wives have complained of what they believe to *be sex discrimination in the Federal Tax Law. These women dislike `being treated in the same way `as wives of city residents and millionaires. Federal law allows a widow t'o deduct from her tax payment `any financial contribution that she has made `to the family estate, but only if she cab prove it with payroll check stubs or similar documentation. Simply working shoulder to shoulder with her husband on `the farm for thirty or forty years is not enough for the I.R.S. One woman stated `that a few years ago, she worked all day in a heavy snow `to get `the cattle to the barn and threw h'ay to them land tha't when she got back t'o the house after dark, she realized that according to I.R.S., `she hadn'It contributed one (lime to the farm that day. Short of a miracle, it would be unrealistic in tills dollar-conscious economy to calculate on restoring the family-sized farm to its former importance. But saving farmland from development for nonfarming purposes is socially desirable, environmentally necessary, and essential to the production Øf food for our growing population-as important to the city dweller `as lit is to the farmer. `We support any legislation which is drafted `to meet the problem which poses such a serious threat `to farming `and to the pa'ttern `of rural life, that is, the transformation of the most productive farmland into shopping centers, drive-in movies, factory and warehouse sites, and housing subdivisions. `Even `a successful and prosperous farmer will find it hard `to resist the tempt- ing `offers of developers when his o'wn taxes are rising unconscionably. Unies.s government can make lit at least equally profitable for him `to retai'ii his land as farmland, he will sell it and `there will be that `much less open space. It `isn't ollly `the farmer and his family who `are the losers if his fields and meadows become paved with asphalt. Something very precious `to us all-some- thing we call `rural life-would become a casualty. Therefore, I support and hope you support the principle of increasing the estate tax exemption to a more reasoiiable and realistic `amount, and I would think that at today's in- flationary standards, $200,000 is a reasonable amount. Equally important to us is the principle that land be valued for estate `tax purposes at `its value for its existing use. If these two principles are followed, then, I think there is hope for our future. Mr. BURLESON. Mr. Mul]iinix, we will be glad to hear from you, sir. STATEMENT OF GENE MULLINIX, COCHAIRMAN, MARYLAND (HOWARD COUNTY) WORKFORCE ON PRESERVATION OF FARM LAND Mr. MULLINIx. The last man here today. Thank you very iunch, Mr. Chairman. My name is Geiie Mullinix. 1 am a young farmer who is scared to death for his future in agriculture. We are located in Maryland. I represent :a group of young farmers in central Maryland who are deeply concerned about their livelihood and their future in agriculture, particularly here on the east coast. Since January 15 of last year, oui~ organizatiion, the Workforce for the Preservation of Farm Land, `has been studying the feasibilities for various methods of preserving farm land in our county. Two facts stand out in our study. A constructive change in the estate tax structure regarding farm land would do as much or more than any other program we have found. Second, an inherent part of a program we have studied is its recognition for estate tax purposes. Howard County is in a unique situation. Because of its proximity to both Washington `and Baltimore metropolitan areas, in the past 5 PAGENO="0867" 853 years has seen a rapid growth and influx of suburbanization along with a rapid escalation in land values. As farmers, this increased land value is a critical problem. We are in a situation where the market value and, therefore, the tax value of this land is at least five times its productive agricultural value. TO us, this market value is oniy a paper value. Under present tax law if any of our farms change hands by inherit- ance, Federal estate taxes must be paid, which in most cases neces- sitates the sale or partial sale of valuthle agricultural land. I can speak from personal experience. Our farm that I am living on and operating right now has been in our family for four generations. The way we are going right now with legislation, my sons will never be able to work our farm which has been, as I mentioned, in our family for over 50 years. My grandfather purchased that farm around 1915 at a ridiculous figure of $2,000 at that time. Today, if tomorrow morn- ing something would happen to me my estate would be approximately $600,000. Unfortunately, about 8 years ago both my `mother and father were killed in a train-auto accident. At that time my mother's and father's estate was valued at approximately $380,000. I was 26 years old at the time and, believe me, when you are 26 years old in farming and want to continue, you have just lost your father and mother, you are scared to death. Our biggest problem, as with most farming opera- tion, was every cent we had was invested in the farm. We had no operating capital or any capital which `I could lay my hands on to pay the estate taxes. Then when they valued my father's and mother's estate they said my mother was not an equal partner and it raised my father's estate into a higher `bracket, making the tax problem much more critical. I can remember many times when my mother had told me that when they first started in farming they started with $2,000 that~my mother had saved, but yet when they were valuing the estate it was not an equal partnership. I think most of these ladies today have mentioned this fact about not being equal partnership. Fortunately, I had an understanding sister who did not demand her half of the estate and allowed me to continue to farm. Plus, I had a lot `of good friends of my father and mother located around us who helped me out financially. Another thing `which I have to admit was a 10-year payment. I am still paying the estate taxes over the 10-year payment. Of course you cannot depend on what the interest rate may `be. It first started out 4 percent. Now we are up to 9 percent. This year I will pay it off because I can borrow it cheaper from other sources. In conclusion, I would like to say that the backbones of American agriculture today is mostly in a closely held family operation with much the same problems in common, an ever-increasing farm value. it is not uncommon for a farm operation to have a value exceeding $300,000. Since these family farms are closely held financially, there becomes an extreme hardship in maintaining the business from one generation to another. With the implementation of proposed legisla- tion this problem could be overcome. Our greatest concern witI~i the present Federal estate tax is atself critical timing. The problem is when the tax is levied, not if it is levied. PAGENO="0868" 854 We feel definitely that it is in the `best interest of agriculture an~d therefore the American people that this proposed legislation increase present estate tax exemption from $60,000 to $200,000. Also that real property, that is, farmlaiid, for estate tax purposes be valued at its present agricultural value. I appreciate your time and consideration, and I hope this committee will give our young farmers in our area a shot of encouragement with legislation that will enable our young farmers to continue because without young men in agriculture today this country cannot survive. `We need the young man in agriculture. The presem~it estate taxes will not allow that. rfhank you. Mr. BURLESON. It is a real inspiration to see a young man who is in the agriculture business. I have met with quite a few in my area. I get encouragement just by looking at you. Mr. Jacobs, do you have an inquiry? Mr. JACOBS. Mr. Chairman, I would just like t.o thank the panel. I apologize on behalf of Father `rimmie. the fact that, Mr. I-Iaiice, you have been here since 9 :30 this morning. I am sure that I speak for the chairman and myself and others in saying that we are paid to be here and I know that you are not. and you are citizens, albeit elected citizens at another governmental level in some cases who have chosen to sacrifice and come here and breathe. some life into the cold statistics. I think that is terribly important. I am sorry to say that even the record of this committee will not give what we in the legal profession call demeanor evidence to this committee. I just want to say to Mr. Muliiiiix that the farm on which my father was born in southern Indiana iii the early part of this century had a market value, lock, stock, horse and carriage, of $368 at the time. It' is worth a great deal more now. Finally, I don't think there could be a more eloquent underscoring of the pievioiis panels' testimony than what you, sir, said at the conclusion of your testimony, that. your wife is going to complete your testimony and type it up. I take it that is part of your operation. So thank you for underscoring the previous panel. I like to see folks work together. Thank you. Mr. BURLESON. Gentlemen, thank you for your patiemice. I join Mr. Jacobs in expressing our regret. for being in such a bind but I know you understand. Thank you very niuch. The committee will adjourn until 9:30 tomorrow morning. [Whereupon, at 6 :10 p.m., the committee adjourned to reconvene at 9:30 a.m. Thursday, March 18, 1976.] 0