VIII. MAXIMUM TAX DEDUCTIBLE CONTRIBUTION FOR PENSION PLANS

Deductions under profit-sharing plans are allowable within the 15 percent of payroll limitations and, when there are credit carryovers up to 30 percent of payroll (to average out 15 percent per year).

Deductions for past service contributions are presently allowable under a pension plan over a 10-year period only if the entire past service liability is paid in full at the inception of the plan. It has always been my view that the original intent of the Congress under the Revenue Act of 1942 was to permit an employer to fully deduct and thereby get all his past service liability paid off in 10 years. This is in the public interest because the sooner the past service is paid off the sooner all the employees will be surer of their full benefits if the plan should terminate thereafter and the plan is forever safer thereby. Past service contributions under a pension plan, however, while ostensibly limited to a 10-year spread only are usually required by the present and proposed tax bill to be extended beyond such period because of the interest element and Internal Revenue Service administrative rules.

A. INTEREST HAS USUALLY EXTENDED DEDUCTION TO ELEVEN AND ONE-HALF YEARS

If past service costs are paid over a period of years, the interest accumulations increase the liability and, since only the original past service liability can be deductible over 10 years, the payments on account of interest are necessarily deductible beyond the 10-year period. This means that it takes about 111⁄2 years under current Internal Revenue restrictions to obtain full tax deductions-including interest. It is therefore submitted that a more equitable arrangement can be effected by allowing the past service deduction to the extent of 10 percent a year plus payments for interest on the unfunded past service liability so as to permit a deduction on account of past service in 10 years. Such a position would insure the deduction without subjecting it to involved calculations.

B. INTERNAL REVENUE SERVICE BULLETIN HAS EXTENDED BEYOND ELEVEN AND ONE-HALF YEARS

Another reason why employers have not been able to deduct their past service contributions in 10 years has been the requirement of the Internal Revenue Service Bulletin re section (p) (1) (A) and (B) of the code which restricts the actuarial assumptions on which tax deductions could be claimed, particularly in self-administered pension trusts or deposit administration group annuity contracts. In other words, an employer who wanted to use ultraconservative actuarial assumptions was not permitted to do so because of the limitations on his tax deductions. Consequently, when such an employer found in actual experience, as a result of the actuarial assumptions which he was permitted to use for tax-deduction purposes, that his fund sustained losses in excess of gains, then the resultant net losses further extended the number of years necessary to fully fund his past service liability.

This created the anomaly of a conflict of interest between the Government's natural desire to limit deductions in a taxable year as against the Government's equal desire to have pension funds fully financed and safe for the employee participants.

Thus, the additional actuarial factors resulting from compliance with the administrative bulletin could have the effect of extending the period required to deduct and amortize the past service for an additional year, or two, or more. Therefore, in the aggregate, it could take some employers a total of say, 12 to 15 years, or more to pay off and deduct their past service liabilities even if they pay the maximum currently tax deductible each year under present Internal Revenue Service administrative rules.

The tax law should permit an employer to be as conservative as he desires in his actuarial assumptions, in order to make his plan as safe as possible, provided, however, that the past service contributions could not be fully deducted any earlier than in 10 years.

C. H. R. 8300 REMEDY-PARTIAL CURE BUT REQUIRES MORE THAN 10 YEARS H. R. 8300 does remedy the defect to some extent because the measure of deduction for past service costs will be 10 percent of such costs at the beginning of the taxable year including past service costs previously funded until

such costs are completely funded. But this still would generally require more than 10 years for full deductions of past service.

D. RECOMMENDATION NO. 10-PAST SERVICE TO BE FULLY DEDUCTIBLE IN 10 YEARS

Consequently, I recommend that the law permit an employer to deduct 10 percent of his initial past service (and supplementary costs) plus interest and excess of losses over gains, so that these can be fully tax deductible in 10 years.

E. RECOMMENDATION NO. 11-PENSION PLAN CARRYOVERS DEDUCTIBLE UP TO 20 PERCENT OF PAST SERVICE BASE

A further recommendation is that the unpaid normal cost plus 10 percent of the base for past service contributions, plus interest and net losses, be permitted as a carryover in any year or years not used up, up to a maximum of 20 percent of past service base in addition to the amounts otherwise deductible in that year. The idea would be still to carry out the original purpose of permitting tax deductions of all normal costs to date plus the full liquidation of the past service over a 10-year period. The principle is similar to a profitsharing plan which can bunch up the failure to contribute the 15 percent of compensation in previous years up to 30 percent deductible in any year. Under the proposed profit-sharing rules an employer can pick and choose any year or years that he desires and deduct up to 20 percent of compensation for that year if he has failed to utilize the full 15 percent in any of the prior years. Similarly, under a pension plan the right to bunch up to 20 percent of past service base in 1 year would make up the employer's failure to use up his 10 percent of past service base in any previous year or years.

F. ALTERNATE RECOMMENDATION NO. 11A-EXCESS CARRYOVER NOT TO EXCEED AN EXTRA 15 PERCENT OF PAYROLL

If desired, this new extra pension plan carryover could be limited to an overall deduction of an additional 15 percent of total compensation of the covered employees to match the extra 15-percent carryover deductible under profit-sharing plans.

IX. AFFILIATED COMPANIES RULE TO APPLY TO PENSION PLANS

Provision is made that in the case of an affiliated group of companies under a profit-sharing plan the companies having profits may make a contribution on behalf of a member having a loss and obtain deductions therefor. No similar provision is made for a pension plan. Although the contributions under a pension plan are not geared to profits, they are of necessity dependent upon profits, because without profits there cannot be a plan of any kind.

It should also be observed that under existing law a deduction is allowed to an employer, within the applicable limits, for a contribution on behalf of his own employees. He is not allowed a deduction for a contribution on behalf of employees of an affiliated company.

Recommendation No. 12—Affiliated companies rule to apply to pension plans

I recommend, therefore, comparable treatments for both pension and profitsharing plans.

X. $5,000 DEATH BENEFIT EXCLUSION FOR PENSION PLANS

The $5,000 death benefit exclusion applies under a profit-sharing plan from which a lump-sum payment is made under conditions giving rise to the long-term capital-gain treatment regardless of whether the employee had a nonforfeitable right to the payment prior to his death. In the case of a pension plan, however, such exclusion is to apply only if the employee did not possess a nonforfeitable right to the payment prior to his death.

The principle of making the $5,000 death benefit tax free, regardless of whether or not it is forfeitable makes sense. Otherwise, the employer would be torn between trying to give his employees vested rights during their lifetimes but subjecting their families to income tax on the death proceeds as against not giving them vested rights during life in order to permit their families to get such proceeds free from income tax at death.

if a company starts a pension plan and then fails to make certain minimum standards of payments thereafter. Now, that has been cured in profit-sharing plans under H. R. 8300, and that same cure should be extended to pension plans.

I have much testimony on that point, but because of the time element involved

The CHAIRMAN. You have that in your statement?

Mr. GOLDSTEIN. Yes, sir, I have.

Then along with that same thing, a great many companies, including companies, for instance, in the textile business, that Mr. Milliken spoke of today, have a system of paying low fixed salaries and then paying discretionary bonuses at the end of each year, so they keep their fixed overhead low, and then when they have good performance they give the bonuses at the end of the year.

Now, H. R. 8300 would exclude the right to put those discretionary bonuses in, in considering the compensation base for pension payments, and that is not a healthy thing and there should not be any interference with the normal development of the running of a business, and I hope that the staff will take that into consideration. The CHAIRMAN. You have submitted that to the staff? Mr. GOLDSTEIN. Yes, I have, sir.

We come next to the question of maximum tax deductible contributions. It has always been my opinion that the Congress intended to encourage taxpayers to get their past service paid off over a period of 10 years from the time the plan is established or a plan is liberalized. The idea is that when a company starts a plan, it has to make some arrangement to take care of all the years of past service of its employees, and that is a large lump sum. That frightens many companies against establishing a plan, because they are afraid of that accrued liability for past service credits.

So the Congress has seen fit and I believe wisely to encourage the rapid funding of the past service credits by permitting a tax deduction toward funding the past service in any year or years that suit the taxpayer, subject to a maximum tax-deductible limit. But in the interpretation of this by the administrative department of the Internal Revenue Service, the amount of the tax deduction has been restricted. So I would recommend that the Congress state in plain English that the purpose is to permit a taxpayer to amortize his past service over a period of 10 years, and I am sure then the details can be worked out to carry out that intent.

The CHAIRMAN. Are you suggesting that?

Mr. GOLDSTEIN. Yes. That is in here, sir.

Then we come to the question of affiliated companies. H. R. 8300 takes care of the case of a profit-sharing plan where there are some loss companies that don't have any money to put in because they are losing money, and yet they have employees working for them in an affiliated group. So they grant that relief, whereby the profit-making companies of the affiliated group can make extra contributions to protect employees of the loss companies. And we suggest that that same procedure be carried out so far as pension plans are concerned, in order to give those employees the same type of treatment.

Then, in a similar manner, there has been a special $5,000 death benefit, which is in the code now, and that has been extended as far as the

profit-sharing plan is concerned, so it doesn't have to be what is called nonforfeitable. We submit that this tax relief also should be afforded to pension plans, because otherwise we will have the anomaly in the tax law that an employer will be torn between two objectives. He wants to give vested rights to his employees who sever employment, so they can take away part of the money that has been contributed. But if he does that, under the H. R. 8300 proposal, then when the employee dies his beneficiaries will be subjected to an income tax on the $5,000; that is, the $5,000 won't be exempt from income tax to the beneficiaries because the right to the $5,000 payment was nonforfeitable, that is, vested, if he had severed employment on the day he died. And so I suggest that, just as in profit-sharing plans, regardless of whether that right is forfeitable or nonforfeitable, there should be relief under pension plans, the same as profit-sharing plans. And that, too, is in my written statement attached.

Then, on the question of retroactive provisions, it has already been suggested, I think by previous speakers, that any changes should be made prospective. I don't believe there have been any abuses, Senator, which would require any urgency to make these things retroactive, when many taxpayers didn't have a chance to know what the rules of the game were.

My final suggestion, which is not included in the written testimony because it came to my mind afterward is, instead of making an arbitrary $4,000 as the breaking point at which an employer can give a lower benefit, that is, the point up to which social security gives coverage, and a higher benefit above that, that instead of having a fixed figure such as $4,000 that will get out of date the minute we change social security in the future, and all pension plans will be correspondingly out of date, we establish in the Internal Revenue Code a flexible point as being the point up to which social security taxes extend. If social security taxes go up to, say, $4,800, then the supplementary private pension plan can have a lower benefit, or none, on the first $4,800. Thus, automatically, both the tax law and the private pension plans can move as social security moves, without any necessity of amending either the tax law or the private pension plans if they have such a flexible provision contained therein.

Thank you very much, Senator.

The CHAIRMAN. Thank you very much.

Mr. Downs.

STATEMENT OF JOHN W. DOWNS, ATTORNEY, BOSTON, MASS.

Mr. Downs. Mr. Chairman.

My name is John W. Downs and I am an attorney from Boston. I represent several of the largest insurance partnerships in that city. I ask permission, sir, to address myself to section 736, payment to a retiring partner or a deceased partner's successor in interest. And, particularly, as to the payments other than for interest in partnership, which we find in H. R. 8300 under that section (A) and (B).

Subsection (a) provides that the distributive share to the recipient of such income of other items for 5 years is treated as a distributive share, and the recipient pays taxes on it.

Subsection (b) then reverses the proposition and changes it from a distributive share to charging the taxes back to the surviving part

ners, on income that they never had and, in the case of my clients, under executed contracts that they have to pay out.

The CHAIRMAN. Mr. Stam, what about that?

Mr. STAM. The question involved there is whether the partnership can take a deduction for these payments to the surviving parties. Now, this 5-year provision, which admittedly has a lot of defects, we are working on that. We have heard this gentleman's testimony and I am pretty sure that you will want to do something about it, when you get into executive session.

The CHAIRMAN. Thank you very much.

Mr. STAM. I have talked to this gentleman about the problem, and I think we will be able to remedy it.

Mr. Downs. Do you want me to cease then?

The CHAIRMAN. There is no use in talking about that any more. Mr. Downs. That covers the whole situation. Thank you very much.

The CHAIRMAN. Thank you.

(The prepared statement of Mr. Downs follows:)

To the Honorable Members of the Senate Finance Committee, Washington, D. C. GENTLEMEN: Your attention is respectfully called to the following provision of the proposed new Internal Revenue Code, H. R. 8300:

"SEC. 736. PAYMENTS TO A RETIRING PARTNER OR A DECEASED PARTNER'S SUCCESSOR IN INTEREST.

"(a) PAYMENTS OTHER THAN FOR INTEREST IN PARTNERSHIP.

"(1) GENERAL RULE. In the case of the liquidation of the interest of a retiring partner or a deceased partner, the amount of income or other items of a partnership allocable to the retiring partner or a successor in interest of the deceased partner, except to the extent provided in subsection (b), shall—

"(A) with respect to payments made within 5 years after the partner's retirement or death, be considered a distributive share to the recipient of such income or other items, and

"(B) with respect to payments made more than 5 years after the partner's retirement or death, be included in the distributive shares of the remaining partners (without increasing the adjusted basis of their interests in the partnership) and excluded from the gross income of the recipient."

I represent several of the largest insurance partnerships in the city of Boston. One of my clients has been in business since 1876, and all of them have had partnership agreements in force for a great many years. These executed agreements provide for the purchase by the partnership of the interest of any retiring or deceased partner and further provide that a retiring partner or the legal representative of a deceased partner may continue as an interested party in the partnership for a term of 10 years.

These agreements are in conformity with Massachusetts General Laws, chapter 175, entitled "Insurance," section 173, as amended, relating to the granting of licenses to brokers. This section provides that executors, administrators, and trustees of the estates of deceased partners may be partners in the partnerships for periods not exceeding 10 years from the death of such partner, for the purpose of protecting any rights of such deceased partner. Under the requirements of the said executed agreements, the insurance partnerships are now paying distributive shares of income to the estates or heirs of deceased partners or to retired partners, and will be required to continue such payments beyond the 5-year limitation set forth in the proposed amendment.

When these agreements were entered into, there was no limitation of time in the Internal Revenue Code, and, of course, such a limitation was not then anticipated. The proposed amendment would insert such a limitation in the law for the first time. Moreover, when the agreements were executed, it was assumed, of course, that the estate of a deceased partner or a partner who had retired would continue to pay taxes on the income received from the partnership throughout the 10-year period just as the deceased or retired partner had paid such taxes during the period of his active participation in the partnership. The proposed amendment would shift the tax burden after the 5-year period to the