Mr. HIGGINS. That is what the whole purpose of our committee has been, to work out a just and equitable solution for the citizens of both types of States. And if it is necessary to make this change in the cost basis in order to do it, we feel that the committee ought to go whole hog and iron out all of these difficulties at this time.

Senator BARKLEY. It seems perfectly obvious to me, as suggested by Mr. Sutherland, that we are doing a rather radical and revolutionary thing here and it is going to take a little experience to reveal the bugs, but as suggested by him, we can iron those out when we come to them. The CHAIRMAN. I doubt very much whether we can here, now, set up a complete change in these systems that will work without further amendment. We will be bound to need of amendments in the future. Mr. HIGGINS. It is our feeling if this works out 90 or 95 percent equalization and makes a 90 or 95 percent correction of a problem which has been a thorn in the sides of all of us and in the side of the Treasury Department for years, that this will be a great step forward. We have received extraordinary cooperation from members of the staff and the legislative draftsmen and people we have conferred with, and the Treasury Department, and I do hope that the Senate and this committee will face this question in the same nonpartisan and bipartisan spirit as have the members of the American Bar Association, who have tried to work out this problem.

Thank you very much.

The CHAIRMAN. You are welcome. We are glad to have had you here.

Mr. HIGGINS. Thank you.

(The prepared statement submitted by Mr. Higgins is as follows:)

STATEMENT ON BEHALF OF THE AMERICAN BAR ASSOCIATION BY ALLAN H. W. HIGGINS, CHAIRMAN OF AMERICAN BAR ASSOCIATION, SECTION OF TAXATION, COMMITTEE ON EQUALIZATION OF TAXES IN COMMUNITY PROPERTY AND COMMON LAW STATES, RE SECTIONS OF H. R. 4790 DEALING WITH EQUALIZATION OF FEDERAL INCOME, ESTATE, AND GIFT TAXES BETWEEN COMMUNITY-PROPERTY AND COMMONLAW STATES

INTRODUCTION

I am Allan H. W. Higgins, of Boston, Mass. I am chairman of a subcommittee of the tax section of the American Bar Association known as the committee on equalization of taxes in community-property and common-law States. This committee consists of 17 members, 6 of whom are from community-property States and 11 of whom are from common-law States.

After a thorough study of the problem, consultation with numerous attorneys and representatives from both common-law and community-property States, and with representatives of the Treasury Department and the technical staff of the Joint Committee on Internal Revenue Taxation, my committee unanimously recommended a proposed bill to equalize Federal income, estate, and gift taxes. The tax section of the American Bar Association unanimously submitted the bill to the house of delegates of the American Bar Association and the house of delegates on September 26, 1947, unanimously approved a resolution recommending the enactment of the bill or its equivalent in purpose and effect. My committee, thereupon submitted the proposed bill to the Ways and Means Committee and the staff of the Joint and Congressional Committee of Internal Revenue Taxation. Thereafter, a substantial number of the recommendations of our committee were included in H. R. 4790, as passed by the House of Representatives on February 3, 1948.

It is my purpose to explain the general provisions of the bill so far as they relate to equalization of taxes between the common-law and community-property States and also to urge upon you certain changes in H. R. 4790, which we think are necessary in order to carry out a fair equalization between the citizens of the various States.

The equalization provisions appear in title III of H. R. 4790-part I dealing with income tax; part II with estate tax; and part III with the gift tax, appearing on pages 12 through 32 of the bill.

PART I. INCOME TAX

Sections 301 through 305 propose to amend the Internal Revenue Code so that husbands and wives, who voluntarily file joint returns, will in substance compute their joint tax by dividing the combined income of the spouses in half, computing the tax thereon, and then multiplying said tax by 2. This is the socalled split-income plan and results in putting taxpayers in common-law States on substantially an equal basis with taxpayers in the community-property States with respect to Federal income taxes. Such provision does not do violence to the fundamental property laws of any of the individual States. The return, as filed, is a joint return which shows thereon the combined income of the husband and wife and their aggregate deductions. It does not apportion to the wife one-half of the husband's income. It merely provides for a method of computing the aggregate taxes of the husband and wife when they elect to file a joint return.

The balance of the sections under part I deal with technical amendments, such as the deduction for medical expenses in the joint return. The amendments with reference to the income-tax provisions are by section 305 made applicable with respect to taxable years beginning after December 31, 1947.

PART II. ESTATE TAX

Subpart 1. Repeal of 1942 community-property amendments

Sections 351, 352, and 353 provide for the repeal of the so-called 1942 community-property amendments to the estate tax. The bar association had recommended that such repeal be retroactive so as to be effective as of the date of the enactment of the Revenue Act of 1942. The House provisions in 4790 provide for such repeal but make it effective as of the date of the enactment of the Revenue Act of 1948.

My committee still feels that the citizens of the community-property States are entitled to retroactive relief from the hardships and inequities of the so-called 1942 community-property amendments. This subject will be covered by a member of my committee, Mr. Paul Jackson, of Dallas, Tex., who will make a statement on behalf of the representatives of the community-property States. Subpart 2. Marital deduction for bequests, etc., to spouse

Subpart 2 commencing with section 361 of the bill provides in connection with the estate tax a special marital deduction for bequests, devises, and transfers to a surviving spouse. This marital deduction is designed to equalize, so far as possible, the estate taxes as between the common-law and community-property taxpayers. Subject to certain limitations, there is deducted from the estate of the first spouse to die the value of any interest passing to the surviving spouse, but such deduction is limited so as not to exceed 50 percent of the adjusted gross estate. The exemption, however, will not apply to decedent's interest in community property as, after the repeal of the 1942 community-property amendments, the surviving spouse in a community-property State will receive half of the community property exempt from estate tax. Although the marital deduction does not apply to community property, it will apply to the separate property held by the decedent in a community-property State. Thus, if such a decedent had at death $300,000, consisting of $100,000 of separate property and $200,000 of community property, his estate subject to estate tax would consist of $200,000-i. e., $100,000 of separate property and $100,000 representing the decedent's one-half interest in the community property. While he could not devise to his wife tax-free any part of his interest in the community property, he could devise his separate property to his wife and secure thereon a 50-percent exclusion. In such a case, if he left his entire $200,000 estate to his wife-i. e., $100,000 of separate property and his $100,000 interest in the community property-he would be taxed on $150,000. This would represent his $100,000 interest in the community property passing to the wife without the 50-percent exclusion, plus the $100,000 of separate property passing to his wife, subject to the 50-percent exclusion.

On the other hand, if a husband in a common-law State died with a $300,000 net estate he could by will also pass $150,000 to his wife free of tax, leaving only

$150,000 to be subjected to the Federal estate tax. Thus, in both cases the tax is the same, whether the property is held on a common-law or a community-property State.

The marital deduction applies in general only to absolute transfers to the surviving spouse in fee simple, except that the transfer to the surviving spouse may be in trust, provided that the trust meets certain conditions.

The limitations in the House bill with respect to transfer in trust for a surviving spouse are much more stringent than those recommended by the American Bar Association; and we submit that they are more stringent than is necessary to protect the revenue. The provisions in the bill proposed by the bar association in substance granted a marital exclusion in all cases where the property transferred by the spouse first to die would be taxable in the surviving spouse's estate, if he or she died directly thereafter.

The new subsection 812 (e) (1) (E), appearing on page 21 of the bill provides that to secure the marital deduction in the case of a transfer in trust for the surviving spouse, the following conditions must be satisfied:

(1) The trust must terminate upon the death of the surviving spouse;

(2) The surviving spouse must be entitled to all the income for her life payable annually;

(3) The surviving spouse must have a power to appoint by will the entire corpus to her estate; and

(4) The surviving spouse must have no power in herself or any other person to appoint or invade any part of the corpus during her life.

Under the House bill, each of these four conditions must be complied with for the decedent to obtain the marital deduction on property passing in trust for the surviving spouse.

Our committee, in drafting the proposed bill followed the principle that, if such a marital deduction is allowed to the estate of the spouse first to die, then whatever part of the interest passing to the surviving spouse remains at the time of his or her death should be subject to the estate tax at that time. This ties in with the situation which existed in the community-property States before the 1942 amendments. Under the community-property law, a surviving wife secured her interest by operation of law; and, prior to the 1942 amendments, such interest was not subject to estate tax. The marital deduction provided for in the bill acts to put the surviving wife in a common-law State on substantially the same basis estate-tax wise. When the surviving wife in the community-property State dies, whatever she has in her estate is subject to the estate tax. Accordingly, the wife in a common-law State who receives property from her decedent husband free from estate tax should be on substantially the same basis.

It has long been the custom to protect wives by placing property in trust. As long as the trust property is taxed at the death of the surviving spouse, the marital deduction should apply irrespective of the varying provisions of the trust. Certainly any limitations as to the application of the marital deduction to trusts should not be so stringently drawn that customary types of trusts will not be permitted to receive the deduction. As long as the corpus will be taxed at the death of the surviving spouse, unnecessary conditions should not be included in the bill.

Condition (1) referred to above requires that the trust must terminate on the death of the surviving spouse. This limitation is unnecessary in order to make the corpus of the trust taxable in the wife's estate. It appears that if the surviving spouse has a general power of appointment, the trust corpus would be included in her gross estate for Federal estate-tax purposes. If there are minor children living at the death of the surviving spouse, it may be desirable to have the trust continue for such minor children. The wife could be given a general power of appointment, and if the exercise or nonexercise of a general power of appointment in the surviving spouse makes the corpus of the trust taxable in her estate, the revenue would be protected.

Limitation (2) also appears unnecessarily stringent in requiring that such spouse be entitled for her life to all the income from the corpus of the trust, payable annually or at more frequent intervals. It is very usual in trusts to give the trustees discretion to pay such part of the income to the beneficiary as the trustees deem advisable. This permits the trustees to even out income between good and bad years, to accumulate for emergencies, and to act generally for the best interest of the beneficiary. It would seem to be sufficient if such limitation provided only that the surviving spouse be the sole income beneficiary of the trust. If the accumulated income is going to be includible with the corpus in the estate of the surviving spouse, the estate-tax revenues are insured.

Limitation (3) which provides that the surviving spouse must have the power to appoint by will the entire corpus to her estate is also unnecessarily limited. It is submitted that it should be sufficient if the surviving spouse has a general power to appointment by deed or will. If she appoints by deed, the Government will collect a gift tax. Moreover, it is submitted that there is no reason why the power should be limited to appoint the corpus of the trust solely to her estate. For reasons above stated, it may well be desired to appoint in trust for children. As long as the surviving spouse's disposition of the property is such as to make it taxable in his or her estate, the deduction should apply.

Similarly, limitation (4) is too restrictive. This provides that there shall be no power in the surviving spouse or any other person to appoint or invade any part of the corpus during here life. Since the marital deduction is to be granted where the gift is outright to the surviving spouse and such surviving spouse could dispose of all or part of the property during his or her life (subject, of course, to gift tax on any gifts), no useful purpose is served by limiting the power to invade the corpus of a trust.

Many trusts contain provisions for the protection of the wife to permit the trustees to pay her part of the principal for emergencies, such as sickness, etc. If the wife had the property outright, she could spend principal for her support; and yet the marital deduction would apply. Accordingly, such power should not be condemned in the case of a trust for a surviving spouse. Such power

of invasion in fact makes the transfer in trust all the more like an outright gift. Accordingly, under a trust, a surviving spouse should be permitted to receive any part of the corpus without limitation.

It is submitted, accordingly, that the limitations in the proposed section 812 (e) (1) (E) should be substantially changed to carry out the general intent of the equalization bill.

Section 812 (e) (1) (D) provides for a special kind of limitation, namely, that the interest of the surviving spouse is to be reduced by any estate, succession, legacy, or inheritance tax applicable to such interest. It is submitted that this is an unnecessary limitation and that the computations required thereunder may well be difficult for the average executor who is preparing the Federal estatetax return. Such a difficult computation is already made part of the law in connection with charitable deductions and has caused considerable difficulty. It is believed that the amount of revenue which would be lost by the failure to impose such a limitation would be negligible. Certainly, the benefits of the bill intended to be provided for surviving spouses should not be limited or reduced in this matter.

Section 812 (e) (2) (B) involves special rules in cases involving community property and this section will be discussed in detail by Mr. Jackson in connection with his presentation in behalf of the representatives of the communityproperty States.

Section 362 deals with property previously taxed. This provides that the deduction for property previously taxed will be limited by excluding therefrom property previously subject to the marital deduction and received from the spouse first to die.

Provision for credit for gift taxes paid

The bill fails to include a provision for credit for gift taxes previously paid but it is our understanding from conferences with the legislative draftsmen that such a provision is under consideration in connection with proposed Senate amendments to the bill.

PART III. GIFT TAX

Part III of the bill seeks so far as possible to put the residents of communityproperty and common-law States on an equal basis so far as gift taxes are concerned. It also provides for the repeal of the 1942 amendments with respect to gifts in community-property States. Such repeal is made effective as of the date of the enactment of the Revenue Act of 1948. The bar association recommended that such repeal be effective retroactively to the date of enactment of the Revenue Act of 1942. Our committee submits that the residents of communityproperty States are entitled to retroactive relief from the inequitable provisions of the 1942 act. Mr. Jackson will also cover this subject in his statement.

GIFTS BETWEEN SPOUSES

The balance of the sections under part III deals with two problems: First, gifts between spouses, and, secondly, gifts to third parties.

Without section 372, gifts between spouses would, after the repeal of the 1942 community-property amendments, be subject to unequal tax results in the community-property and common-law States. If community property is given to the wife, the whole becomes her separate property, yet the gift tax is laid only on the husband's half interest, since, under the community-property law, the life is already the owner of the other half. On the other hand, if a husband in a common-law State gives property which he has accumulated during the marriage to his wife, the whole value of the property is subject to gift tax. Accordingly, to equalize the gift tax, section 372 provides that in gifts between spouses (other than of the donor's interest in community property) only onehalf of the value of the gift shall be taxed. This section, when correlated with the estate-tax provisions, achieves substantial equity.

The operation of section 372 is illustrated by the following example: If a husband gives his half interest in community property which has a total value of $100,000 to his wife, the gift under the community-property law is only valued at $50,000 and the gift tax is laid only on this amount. The 50-percent exclusion provided for in section 372 will not apply to the donor's half in the community property. On the other hand, if a husband in the common-law States gives his wife $100,000, the 50-percent exclusion will apply and the tax will be computed only on an equivalent $50,000.

Gifts to third parties

Gifts to third parties present an additional problem. A gift of community property, after the repeal of the 1942 amendments, when made to a third party is deemed to be made half by the wife and half by the husband. Each has a separate exemption and can compute the gift tax separately. The gift tax on such gifts in community-property States is accordingly lower than if the whole gift were chargeable to the donor husband in the common-law State. To equalize the gift taxes on such gifts, section 374 provides that where a gift is made by either spouse, the spouses may in filing gift-tax returns treat such gifts as having been made one-half by each spouse. Thus, if a father gives $100,000 to a son, the father and mother can, for gift-tax purposes, compute the tax as though each had made a gift of $50,000.

As in the case of the marital deduction under the estate tax, a provision was inserted in the bill (the proposed new section 1004 (a) (3) (D)) so that transfers in trust could have the benefit of the marital deduction for gift-tax purposes, provided the trust met certain conditions. The House bill contained the same limitations with respect to such transfers in trust for gift-tax purposes, as were contained in the estate-tax provisions. Our comments and our recommendations, with respect to these conditions, are substantially the same under both provisions; and, if corrections and changes are made under the estate tax, similar corrections and changes should be made under the gift tax. The election or consent of the spouses to split gifts to third parties is to be governed by certain provisions of 374 (f) (1) (B) and (2). Our committee submits that these provisions with respect to the manner of exercising the election are far more limited than is necessary or desirable. Subparagraph (2) first provides that the consent under the subsection (1) be signified at such time and in such manner as is provided under regulations prescribed by the Commissioner with the approval of the Secretary. Secondly, the section provides that the right to consent shall not exist unless the return was filed on time.

We submit that the time and manner of making such an important election should not be left to the discretion of the Commissioner.

Even more serious is the deprivation of the taxpayer's rights by his mere failure to file his gift-tax return on time.

Of all the types of returns, which are required to be filed with the Treasury Department, there is less knowledge on the part of taxpayers about gift-tax returns and more tendency to file returns late. Many taxpayers either do not know about the gift tax or have misconceptions as to the amount of the exclusions or the specific exemptions. Lawyers throughout the country can cite instance after instance of taxpayers who have unintentionally failed to file gift-tax re