Today, alternative investments such as Treasury Bills are available with yields of 16% and more. Since alternative investments offer substantially greater returns, the value of minority positions in closely held businesses are correspondingly reduced. For a willing buyer to purchase a minority interest in a closely held business, the price today would have to be discounted by a substantially higher percentage to reflect the fact that alternative, guaranteed returns of 16% and more are available. The law concerning valuation of closely held business interests has not kept pace with changing economic conditions to reflect the existence of such alternative investments yielding substantially greater returns. Indeed, the law on valuation of closely held business interests does not even fully take into account the fact that the "willing buyer/willing seller" standard is simply a legal fiction. In reality, there is no market for most minority interests in closely held family businesses. only way an unrelated buyer would purchase an interest in a family corporation is if the price were substantially depressed. The Thus, I conclude that if "death and taxes at death" are to remain with us, there is a compelling need to revise the standards applicable under present law for valuing closely held businesses. To identify this problem, however, is not to solve it. We have examined many alternatives to the "willing buyer/willing seller" standard. For simplicity, an arbitrary, bright-line approach would be ideal. This would reduce conflict, uncertainty and expense, including legal expenses. Unfortunately, no such bright-line solution is practical when applied to the broad range of American businesses. A need exists for a standard such as the "willing buyer/willing seller" standard to adjust for the enormous diversification of American business. Therefore, we believe that the preferred solution is to leave the present rules intact and allow an additional discount for estates which are composed in part of closely held business interests. We believe that an additional discount of 50% from the value those interests would be assigned if the businesses did not meet the test of being closely held would be reasonable. In order for an estate to qualify for this special valuation, recommend that the value of the closely held business interest in a decedent's gross estate constitute at least 25% of the value of the gross estate or 35% of the taxable estate. A closely held business should be defined as one (1) where 50% of the outstanding stock is owned, directly or indirectly, by or for not more than five individuals as required in Section 542 (c) (2) of the personal holding company provisions, (2) involved in an active trade or business, and (3) whose stock is non-readily-tradable stock within the meaning of Section 6166 (b) (7) (B). Since the purpose of this family business valuation provision is to permit family transfers, and the estate tax rates rise with increases in value, we recommend that there be no limit on the absolute size of the business or the interests which may qualify under the provision. The policy of permitting intra-family transfers of family businesses should apply no matter how large the business. In 1976 Congress recognized that inflation was pushing farmers into increasingly higher estate tax brackets. To avoid forced liquidations of family farms and real property used by family businesses, Congress in that year enacted Section 2032A, the special farm use valuation provision. A similar provision such as the one described above for closely held businesses whose value is not based on real and tangible personal property within the narrow meaning of Section 2032A should now be enacted to acknowledge that inflation has produced bracket creep for all taxpayers owning family businesses and to recognize that the valuation techniques presently applied to determine the value of family businesses do not adequately take into account the economic conditions of our time. APPENDIX J STATEMENT OF CONGRESSMAN BILL EMERSON BEFORE THE HOUSE SMALL BUSINESS SUBCOMMITTEE ON TAX, ACCESS TO EQUITY CAPITAL AND BUSINESS OPPORTUNITIES ON ESTATE AND GIFT TAXES AS THEY AFFECT SMALL BUSINESSES Mr. Chairman, I appreciate this opportunity to submit testimony before the Small Business' Subcommittee on Tax, Access to Equity Capital and Business Opportunities on the Effect of Estate and Gift Taxes on Small Businesses. I represent the 10th District of Missouri, an area in which family farms and small businesses are truly essential elements of the economy. In fact, most of the businesses in my district are family owned and operated. There are alot of farms, grocery stores, retail clothing and shoe stores, equipment and farm supply stores. I am, as are the vast majority of my constituents, vitally concerned by the increasingly serious problem tax policy has caused for the transfer of property from one generation to the next. Throughout our economic history, one of the most consistent sources of stability and strength has been, and continues to be, the family-owned enterprise. Indeed, farms and small businesses that are passed from one generation to the next have served as the backbone of American progress and productivity. Unfortunately, this segment of our economy has, in recent years, become increasingly threatened by the combined effects of inflation and tax policy that have come to present tremendous obstacles to the transfer of property to succeeding generations. Today, young people and spouses who inherit the family business find themselves faced with an excessive tax burden which results in their being forced to sell all or part of their inheritance just to pay Federal estate taxes. The end result of this calamatous situation is that years of hard work and sacrifice are lost rather than carried on by those who know it best. The additional irony of this situation is that, as a source of Federal revenue, estate taxes will amount to only one percent of IRS collections this year - an amount hardly worth the adverse impact of the tax. The estate and gift tax became a permanent part of the Federal tax system in 1916. A powerful argument for its acceptance at that time involved the question of social justice. It was felt that large concentrations of entrenched wealth ran contrary to the spirit of a free society and that this tax could correct the threat by breaking up substantial fortunes after one generation and redistributing wealth to the middle and lower rungs of the economic ladder. But, in 1981, we must realize and accept the fact that the original intent of the law no long applies. Indeed, estate and gift taxes have, in fact, aggravated the gap between the haves and have nots. The wealthy have been able to avoid the tax by careful estate planning while moderate-income families bear the brunt of the tax burden. In fact, in 1979, more than 76 percent of inheritance tax returns processed by the IRS represented gross estates of less than $300,000. This fact clearly demonstrates that Federal estate tax law not only is unfair but surely defies its original intent of social justice. The declining rate of productivity has been one of our country's overriding economic concerns in recent years. In a broader sense, So has the perpetuation of the free enterprise system. In my view, the estate and gift tax not only stifles productivity by imposing a "post-mortem" tax on hard work, but restricts the continuation of the foundation of our free enterprise system the family business. A small businessman |