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An owner hits his late fifties, maybe early sixties. He looks around, looks at the gift taxes if he wants to pass it, give it to his children.

He looks at the estate taxes.

He decides the heck with it and shuts his doors and sells his equipment. Out the window go the jobs, the technology, and the productivity that has been established over many years.

This is an increasing trend in this industry. That is just a way of pointing up the nature of the problem and how much estate and gift taxes work against the building of small business in this country.

As I am sure you are aware, the small business share of our national economy has fallen dramatically over the past 15 years. In our opinion, estate and gift taxes are one of the big reasons that this has happened.

I will not repeat all the suggestions that were made by previous witnesses, all of which are good. I will just briefly point out some of the steps toward the total elimination of gift and estate taxes that have been proposed, most of which are steps in the right direction. The administration, I think, showed a recognition of the problem of small business in their proposals which would allow for a $600,000 exemption. The unlimited marital deductions phased into 1982 and the increase in the gift tax exclusion to $10,000.

I think, Mr. Chairman, you yourself have recognized and gone even further in your introduction of H.R. 3882 with a full exemption for spouses, the valuation of business at 50 percent of their value, and the $600,000 exemption for estate taxes, and the other provisions of that bill.

This is a further recognition of the problem. The problem has been aggravated over the years by such characteristics as bracket creep in estate taxes. There are several other problems in the estate taxes now which could be improved without any change in the law-and I think we need a change and it appears that one seems to be coming. For example, the time allowed for the payment of estate taxes should be increased.

Sections 6166 and 6166(a) of the IRS Tax Code alone often forces many businesses to liquidate simply because of the pressures on them from IRS.

Such things as graduated payments, and interest only during the first few years of those payments, would be very helpful.

I would be more than happy to answer any questions you might wish to ask.

[Mr. Hahn's prepared statement follows:]

PREPARED STATEMENT OF BRUCE N. HAHN, MANAGER, GOVERNMENT AFFAIRS, NATIONAL TOOLING & MACHINING ASSOCIATION

Mr. Chairman and members of the Committee, My name is Bruce Hahn. I am manager of Government Affairs for the National Tooling and Machining Association. Our association represents 12,500 small businesses employing approximately 300,000 workers in the contract tooling and machining industry.

Our industry is comprised almost entirely of family owned and operated businesses. Most of our members started their careers as apprentice machinists. Like Americans everywhere, they had a dream of one day being their own boss and they have worked, worked countless 80 hour weeks, to make that dream come true.

Our members are successful. Often starting with nothing more than a high school diploma and a strong desire to succeed, they have built businesses that occupy an

important spot in the local economy. The average machine shop employs 30 people, has capital assets of $1.1 million, and does $1.5 million worth of business a year. Our members have another common American dream-to leave a legacy, their business, to their children. Very frequently, the children of owners work in the family business. Both parents and children take great pride in their business and both hope to continue it in the family.

Many of these businesses are destroyed by estate and inheritance taxes which work to prevent the transfer of assets from one generation to the next. A small business is not a large family fortune. Most of their assets are tied up in the business, a product of a pattern of continuing reinvestment for the growth of the business.

When an estate consists primarily of a machine shop, most of the assets are tied up in the building and equipment. In order to raise the cash necessary to pay the estate taxes, most families find themselves in the difficult position of needing to liquidate the business. Taking out life insurance on the owner, sufficient to cover the $1 million in assets, costs an astronomical $2,500 to $3,500 for premiums per year.

Hundreds of machine shops are auctioned off each year. In fact, there are industrial auctioneers who specialize in job shop auctions. While some shops go out of business because of low profitability, most of these auctions sell off profitable, viable shops. The saddest commentary of all, is that many shop owners, seeing what will happen when they die, decide to sell out a viable ongoing business when they retire. Whether a shop is sold at auction or to a larger business, whether it is sold before the owner dies or after, these sales result in the loss of jobs and technology. Small businesses provide 43 percent of the GNP, 58 percent of non-farm business employment, and 66 percent of all new jobs. Forcing their sale, because of estate taxes, is damaging our Nation's economic health.

The White House conference on small business listed revising "estate tax laws to ease the tax burden on family-owned businesses and encourage the continuity of family ownership" as their fourth priority. Thirty of our members were at that conference and they concur.

Numerous pieces of legislation have been introduced that deal, in part, with the question of estate taxes. We believe the bill, cosponsored by Congressman Nowak and many Members of the Ways and Means Committee, H.R. 3882, provides the broadest response to this problem. We feel estate taxes should eventually be repealed entirely. Those assets have already been taxed once, and estate tax laws have done much to reduce the small business share of our GNP. We believe Congressman Nowak's bill is a good step in that direction.

Small business will especially be helped by H.R. 3882 because of the full exemption for spouses provision. In most of our shops, the man might own the business but his wife worked as long and hard as he does. They have built the business together but, under current law, her contribution doesn't count for anything. This proposed bill will change that.

Small business will also be helped by valuing interest in a closely held business at 50 percent of fair market value, the reduction of tax rate, and raising the amount exempt from any tax at all to $600,000. With these provisons, our members will still have taxes to pay but they will at least have a better chance of being able to pay those taxes without having to liquidate their family's business.

Thank you.

Mr. Nowak. It was suggested by Mr. Kolbe that deferral of the tax, especially in the first instance, be made until the business can run. During this period of deferral a better business decision, a sounder decision, can be made.

I would expect that would be especially helpful to your constitu

ency.

Mr. HAHN. Yes. I think so.

Another characteristic of our members-and I think for most small businessmen, that their business tends to be the major investment in their life.

I know our people in Buffalo, in Illinois, all over, they tend to reinvest their money in their businesses. A man with a typical shop, whether it be in Buffalo or anywhere else, this 30-man shop has $1.1 million in assets. He probably has a very typical house. He

probably does not have a lot of expensive toys or airplanes or big boats.

They literally put their money back into their business and that is their estate. They do not have a big kitty over here or generally do not have a lot of extra assets which they could use, which they could liquidate for gift or estate tax purposes, so that they can maintain their business.

This is also the nature, I think, of many, many small business industries.

Mr. NOWAK. When we look at the total impact of this estate tax rate, we have a feeling that the liquidity problem is one that is being planned for. Of course, that cost goes into the business, perhaps many years before the actual death of a partner occurs. I would think that this is also somewhat of an inflationary cost to a business. Many of your people buy insurance on a regular basis as they get up in age to try to cover the estate tax. Of course, they have to add that to the cost of the product if they are going to make a profit.

Mr. HAHN. Yes, that is true, but insurance, say, for this typical firm that has about $1.1 million in assets, the cost for $1 million of life insurance is $2,500 to $3,500 per year. It is a very competitive business, and against the profit margins, the typical small businessman looks at those figures and considers it quite high.

It is quite high to a person with a normal standard of living; $3,500 a year for insurance.

Yes, they probably would be wiser and would be using better long-range planning if they had carried life insurance and planned ahead for the size of their business 15 or 20 years down the road, but they do not. They just do not.

Mr. NOWAK. You mentioned an auction merchant in this business. Some of the other groups at least have different types of operations. You have a consequence of reducing the number of small businesses out there as larger business eats up their competitors. In your organization aren't most of these bought by new small businessmen, so to speak? Or is there a new tendency in the tooling industry?

Mr. HAHN. Because of the nature of this business, I would say you are probably right.

Most of the equipment is bought by other small businessmen. Some may go to larger corporations, but it is generally very highly specialized, very sophisticated equipment which is primarily of interest to these job shops which are really specialists in almost every case in the type of work that they do.

Another way of going out of business, of course, is to sell out to a major corporation with a stock exchange. That is a very common situation, and I think created by the estate and gift tax laws. Mr. NOWAK. At that time it would be attractive to sell out to either an individual or a corporation, and I suppose they look at a capital gain rate which is less onerous than the estate tax rate, if you are talking about substantial dollars. Is that correct?

Mr. HAHN. Much less.

Mr. Nowak. As I said, your testimony will be incorporated in total. We have, I believe, focused on the major problems in this

area. We want to get this information over to Ways and Means as

soon as we can.

Counsel, do you have a question? Minority counsel?

Mr. CENTNER. One of the things that stands out when you have tooling and machining people is we talk about small business as if there is an average small business.

I think that your industry points up the fact that there is probably no such thing. I was wondering, while we still have Mr. Kolbe and Mr. Tonneson in the audience, would you provide us with a profile of some of the industries in your associations and of your industry, including not only the estate value but the ratio of estate tax liability to asset earnings?

I think in the case of an association representing a particular industry that is probably easier. Can you break it down by the associations in capital intensive, labor intensive, inventory intensive, that sort of thing, so we can get an idea of what the real estate tax bite is rather than talk about an average small business, which I think is very, very difficult?

Mr. HAHN. You want the ratio of the estate tax

Mr. CENTNER. You mentioned they have a $1.1 million business. They are not making $1.1 million.

Mr. HAHN. They are doing approximately, I think, $1.2 million a year.

Mr. Nowak. You are talking about in sales?

Mr. HAHN. Sales.

Mr. NOWAK. Their assets?

Mr. HAHN. Are $1.1 million.

Mr. CENTNER. Again their profit is not nearly at that level after you pay your employees, you pay your operating costs?

Mr. HAHN. You net somewhere around, I think-and I can get that information-somewhere around 2 or 3 percent. You are talking-that is low dollars.

Mr. CENTNER. The estate tax can wipe them out in terms of what they have coming in to pay that estate tax with. That is the point I am getting at. We would like to have a profile of some of the major businesses in the New England area, some of the people in your industry, some of the people in Wisconsin.

We will be making the request of the Utah Council and the Mountain States Association.

I am not sure when people talk about an estate tax reform and helping small business that there is not an impression in everybody's mind as to what a small business is.

I happen to be very curious as to whether you can make that kind of statement.

The $600,000 level, for example, it strikes me we have talked about today would not be any real great-would be of some help, I suppose, but wouldn't be the greatest help you could get whereas it might help an ice cream store down the street.

Mr. NOWAK. I think you are right. You are going to have a great variation.

Mr. Kolbe testified that probably a better average is $4 to $5 million. Is that correct?

Mr. KOLBE. I would think $4 to $5 million total value would be an average what I would call small business manufacturing a product around Racine, Wis.

Mr. NOWAK. For manufacturers, I am sure you would have that kind of average economic size.

Mr. KOLBE. At a $5 million value, I have this chart on page 3 of my statement that a $5 million value, through two deaths, properly utilizing a marital deduction and a tax deferred trust, would have total tax on that business-and I am assuming other assets would use up the unified credit of $175,000 each time-the total tax would be $2,050,000. That is 41 percent of the total value of the business. That may be aggravated especially by-maybe even further aggravated by the fact that the value put on the business by the Internal Revenue Service may well include a goodwill factor which is not a balance sheet asset.

Mr. Nowak. That disappears awfully quickly if the operation doesn't continue at that level or at least stay even?

Mr. KOLBE. It disappears and the only way that you can realize it in cash would be to sell the whole business. So it could be with a goodwill factor, that that 41 percent of total value could be 60, 70 percent of hard asset value.

Mr. CENTNER. And certainly could be several times what they actually make off the business.

That is, I guess, what I am getting to. A farm may be worth $1 million dollars, but they may only be making less than $100,000, off of it. So, in effect-I guess what I am saying here is people think in terms of this is a business worth $5 million, and that is a lot of money, but if it is a capital intensive firm, the firm itself is not really worth that in terms of income to the person who owns it. So they may not be wealthy people at all even though they have a $5 million business.

Mr. KOLBE. If that $5 million is the value, that money is in machinery, equipment, plant. That is not cash, of course. It is not available to pay any taxes. A business worth $5 million, it might— if it were to sell, say for 10 times earnings, if that were the value of it, it would be a company making $500,000 after taxes each year. It is probable-with that, with that $500,000, it probably cannot replace its capital equipment every year.

Now, the Internal Revenue Service also will take the position that where you are accumulating funds prior to death in anticipation of paying these estate taxes, that that may not be a proper accumulation of funds for income tax purposes and they may want to levy an accumulated earnings penalty tax.

So, you see, a person gets caught between the rock and the hard spot everywhere they turn with this.

Mr. CENTNER. Again I get back to the fact if we can get a profile, I would like to see us come up with a picture that shows the $5 million estate, which so many people would think is a big estate, is, in fact, in relative terms, not a big estate at all if it is a small business or a farm.

If you can help us with figures to paint that picture, we would sure appreciate it very much.

Mr. HAHN. I would be happy to do that. Let me adjust one comment in support of this gentleman.

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