duction would be allowed. Section 372 of the bill provides what is intended to be comparable gift tax treatment. An analysis of these sections of the bill reveals that they not only fail to bring about equality of treatment, but in fact produce inequalities not present under existing law. Thus, where in a common-law State the estates of husband and wife are substantially equal and one dies leaving his property to the survivor, an estate tax would, by reason of the marital deduction, be payable on only onequarter of the family wealth, i. e., on one-half of the decedent's half. However, in the corresponding situation in which the family wealth consists of community property earned by both spouses, an estate tax would be payable on the death of the first spouse to die with respect to one-half of the family wealth. Under these circumstances, a similar discrimination would result as to gifts made by one spouse to the other by reason of the gift tax marital deduction. This discrimination under both the estate and gift taxes is inherent in the approach to equalization set forth in the bill. To take another example, a husband in New York who has earned all the family wealth may give half to his wife by gift, and, under the bill, pay gift tax on one-quarter. At death, he may leave his remaining half to the wife and pay estate tax on one-quarter. A husband in the same situation in Texas would pay no gift tax but would pay an estate tax on one-half at death. The sum of the gift tax on one-quarter and the estate tax on one-quarter in the case of the New York husband would be less than the estate tax on one-half in the Texas case, because of the lower brackets, lower gift-tax rates and two sets of exemptions. Thus, in this type of situation, community property would be discriminated against; there would continue to be inequality of treatment. On the other hand, where the New York husband gives one-half the family property to his wife during life, and the remaining half to his children at death, he would pay a gift tax on one-quarter and an estate tax on one-half of the property. The total taxes paid by the New York husband would exceed the estate tax payable by the Texas husband who left his half of the community property to his children and who was not required to pay gift tax on the half acquired by his wife by operation of law. In this case, the discrimination would run in the opposite direction, i. e., against common-law property. Discrimination may also occur where the wife dies first. If the wife in Texas leaves to her surviving husband her half interest in community property earned solely by the husband, she would pay an estate tax on such half and the husband, at his death, would pay estate tax on the entire property. The New York wife would pay no tax at her death, an estate tax on the whole estate being payable upon the husband's subsequent death. In this situation, the total taxes paid by the spouses in Texas would be greater than the total taxes imposed with respect to the New York spouses' property. Conversely, the Texas family would have the advantage if the wife left her half of the community property to the children. In that case, the total taxes payable by the spouses owning community property would be an estate tax on the wife's half plus an estate tax on the husband's half, as compared with a tax, computed at higher progressive rates and with but a single exemption, on all the property of the New York husband. These examples serve to demonstrate that the estate- and gift-tax amendments in the bill will not produce equality in the transfer-tax treatment of community and noncommunity property. Furthermore, a comparison of the tax consequences under the bill with those of the present law shows that the bill will produce inequalities where they do not exist under the present law. Effect on estate planning The method by which equalization is sought is inherently defective because the amount of the proposed marital deduction would depend on the amount of property going from the New York decedent or donor to his spouse. Thus, if only one-third of his property goes to his spouse, the amount of the deduction would be equal to the value of such one-third. In the case of community property, however, each spouse acquires title to one-half by operation of law. Equality, therefore, would be obtained under the system of taxation proposed in the bill only in the event the deceased or donor gives his spouse one-half of his property. Since it is a frequent practice in common-law States for a wealthy husband to give his wife a life interest in his estate with remainders to his children or other beneficiaries, equality of treatment would be achieved only by interfering to a large extent with this long-established pattern of family dispositions. No such criticism may properly be directed against the 1942 amendments. Estate and gift tax provisions not necessary to income splitting The estate and gift tax treatment of community and noncommunity property provided in H. R. 4790 is not, as has been suggested, a proper adjunct of the income-splitting provisions of the bill. The proposed system for income splitting by husbands and wives constitutes a single, Nation-wide plan for taxing income from all sources, whether derived from earnings or investments or from separate or community property. Such a plan is not concerned with local rules of ownership of income. Instead, it overrides such rules and sets forth a uniform concept for determining the tax on family income. The estate and gift tax provisions of the bill, however, do not create a single, over-all plan for taxing transfers of family wealth. On the contrary, the bill provides one method for taxing transfers of community property, based on the local rules of property ownership peculiar to such property, and another method for taxing noncommunity property, based on the local rules of property ownership peculiar to the latter property. The bill disregards the fact that by according full recognition to the formal distinctions between the two systems of property ownership, disparities of tax treatment necessarily arise. It then attempts, as a means of obtaining equality in the taxation of transfers of both types of property, to conform transfers of noncommunity property to the pattern of transfers peculiar to the communitypropery system, through the use of a marital deduction. Equality of taxation cannot be successfully achieved through a hybrid-tax system, such as that created by H. R. 4790, which implements rather than disregards the formalities and technicalities of local rules of property ownership. Terminable interests The hybrid plan for taxing transfers contained in the bill is fundamentally defective in another important respect. Sections 361 and 372 disallow a marital deduction with respect to certain terminable interests in property passing to a surviving spouse, or transferred by gift. Typical examples of terminable interests which are not deductible are life estates or annuities given to a spouse, where remainder interests pass to other beneficiaries. Thus, where a decedent leaves property in trust, providing for the payment of the income from the trust to his wife for life with remainder to his children, no marital deduction may be taken. The apparent purpose of this rule is to insure that all the property of the family is included in either the estate of the husband or of the wife. The difficulty is that the husband may easily avoid this rule by use of other types of terminable interests which are deductible under the bill. The bill permits the deduction of terminable interest purchased by the donor or decedent or by the executor at the direction of the decedent. This creates a wide avenue for avoidance of tax upon either spouse. Thus a person who wishes to provide a life income for his spouse with remainder to his children without losing the benefit of the marital deduction need only purchase, or direct his executor to purchase, a life annuity for his spouse with part of his estate and to hold the balance in trusts for the children. The value of such annuity would be a marital deduction from the decedent's gross estate, and would not thereafter be includible in his spouse's gross estate. The value of the annuity would thus completely escape taxation. Tax could similarly be avoided in the case of other purchased terminable interests, such as leases and insurance proceeds payable in installments. On the other hand, if the marital deduction were not allowed as to any terminable interest, so that there would be deductible only such property transferred to a spouse as would be subject to transfer tax in her estate, a further large area of inequality of treatment as between common-law and community-property States would be created, in view of the fact that terminable interests may be held as community property. This dilemma appears to be inherent in the "equalization" plan of the bill. The 1942 amendments present no such problem. Tracing of property One of the chief arguments advanced by proponents of the repeal of the 1942 amendments governing community property is the supposed difficulty in some instances in tracing such property to its source. While the existing problem does not in fact appear to be serious, this bill itself substitutes some new tracing requirements. Sections 361 and 372 of the bill properly provide that no marital deduction may be taken as to separate property which was at any time acquired in exchange for or through partition of community property. It is apparent that, under these provisions, it will frequently be necessary to trace separate property passing between spouses back to its original source. Accordingly, to the extent that the criticisms of the 1942 amendments based on tracing difficulties may be valid, H. R. 4790 is open to the same type of criticism. Basis In addition to the difficulties in the estate- and gift-tax treatment of spouses, the plan incorporated in the bill also gives rise to income-tax problems involving basis for gain or loss. Under existing law the basis of property acquired by a surviving wife by bequests, devise, or inheritance from her deceased husband would be its value at time of his death. The bill makes no change in the rule, even though the marital deduction taken by the husband results in exclusion of the property, from his taxable estate. In the case of community property, however, the surviving wife's basis for her half of the community, however, the surviving wife's basis for her half of the community property would be its cost to the community, since such half was not acquired by bequest, devise, or inheritance. Where the property has appreciated in value this operates disadvantageously to community property. In determining the appropriate policy respecting basis, consideration must be given to the relationship between noncommunity property qualifying for a marital deduction and the surviving spouse's interest in community property. The plan of estate taxation embodied in H. R. 4790 treats property passing to a surviving spouse and qualifying for a marital deduction as the equivalent of a surviving spouses' interest in community property. Accordingly, it may be presumed that similar basis treatment should be given to both types of property. Similar treatment, however, cannot be achieved if the estate-tax plan of H R. 4790 is not accompanied by a change in the present provisions of law governing basis. The bill fails to deal with this question. If, in spite of their fundamental and serious defects, the estate- and gift-tax provisions of this bill should be enacted, it would appear that a satisfactory basis for determining gain or loss could only be established by eliminating entirely the provisions of existing law which permit the basis of inherited property to be determined by reference to the value of the property at the time of death. This type of treatment would provide equality for income-tax purposes of both community and noncommunity property. Other technical defects The bill in its present form does not deal with a number of troublesome technical problems which must be resolved and presumably will be by amendment. These involve matters relating to proper allowance of credit for gift tax in the case of property subject to the marital deduction, cases of disclaimers of legacies and other matters. However, even assuming that these problems are satisfactorily disposed of, it must be recognized that their solution will unquestionably lengthen and further complicate the estate- and gift-tax provisions of the bill, which already are far more lengthy and complex than can be justified by the tax results they achieve. EXHIBIT 1 Estimated effect of House bill (H. R. 4790) on budget receipts, expenditures, and surplus, fiscal years 1948 and 1949 1 Internal Revenue Code, as amended by the Revenue Act of 1945. 2 Represents increase resulting from larger individual income tax refunds under H. R. 4790. ource: Estimates under present law are from the Budget of the United States Government for the fiscal r ending June 30, 1949. EXHIBIT 2 Wholesale, retail, and consumers' price indexes, 1939 to date Source: Wholesale and consumers' prices, U. S. Department of Labor; retail prices, U. S. Department of Commerce EXHIBIT 3 Percentage distribution of positive and negative savers, by income groups of family units, 1946 Source: Survey of Consumer Finances, pt. III, Consumer Savings in 1946 and Ownership of Selected Nonliquid Assets, Federal Reserve Bulletin, August 1947, table 13, p. 12. |