In order to clairfy section 736, I suggest that after subsection (a) (2) there be added a new subsection numbered (a) (3), as follows: "PAYMENTS OF PERSONAL SERVICE PARTNERSHIPS WHOSE ASSETS ARE NOT SIGNIFICANT AS COMPARED WITH INCOME "In the case of the liquidation of the interest of a retired partner or a deceased partner of a personal service partnership whose assets are not significant as compared with income, the amount of income or other items of a partnership allocable to a retiring partner or a successor in interest of a deceased partner, shall be taxable to the recipient at ordinary rates." I ask the privilege of submitting a substantiating statement for the record. MEMORANDUM RE H. R. 8300 The following discussion relates to sections 736 and 751 (more particularly sec. 736) of H. R. 8300. In reading these sections in the light of the report of the Committee on Ways and Means it is believed (1) That these sections do not apply to a personal service partnership having no capital and owning no assets; that, if so, then in the interest of clarification, subparagraph (B) of paragraph (1) of (a) of section 736 should be amended with the prefatory words, "Except as to personal service partnerships having no capital and owning no assets," so that such paragraph (B) shall read: "Except as to personal service partnerships havings no capital and owning no assets, with respect to payments made more than 5 years after the partner's retirement or death, be included in the distributive share of the remaining partners (without increasing the adjusted basis of their interest in the partnership) and excluded from the gross income of the recipient." (2) In the event that the foregoing sections, and particularly section 736, should be considered to include personal service partnerships having no capital and owning no assets, then and in that event, in order to recognize the realities in connection with such partnership and the well established law of the country, said paragraph (B) heretofore referred to should be amended as above set out. In reading sections 736 and 751 in the light of the report of the Committee on Ways and Means, it is apparent that, inherent in these sections is contemplated a partnership possessing capital or assets, or both. The discussion of the intent of the Ways and Means Committee with respect to the foregoing begins on page 70 of the report of that committee. It is stated on page 70: “*** and at the same time to prevent the use of the sale of an interest in a partnership as a device for converting rights to income into capital gain." As appears clearly from a reading of pages 70, 71, and 72 of the report, this basic purpose was to be accomplished by treating certain enumerated types of income separately insofar as taxes are concerned, from the sale of a retired or deceased partner's interest in the partnership. This is made apparent in paragraph (B) above referred to of (a), section 736, by the words in parenthesis, "(without increasing the adjusted basis of their interest (of remaining partners) in the partnership)." In paragraph (1) on page 70 of the report, the committee states: "Under present decisions the sale of a partnership interest is generally considered to be a sale of a capital asset, and any gain or loss realized is treated as capital gain or loss. It is not clear whether the sale of an interest whose value is attributable to uncollected rights to income gives rise to capital gain or ordinary income." Basically, it is apparent that the committee was considering the item of "uncollected rights to income". The committee made it clear by this expression that it had reference (par. (2), p. 70 of the report) to unrealized receivables or fees, and/or substantially appreciated or depreciated inventory or stock in trade. In the third paragraph on page 71 of the report, in referring to "unrealized receivables or fees", the committee stated: "The provision is applicable mainly to cash basis partnerships which have acquired a contractual or other legal right to income for goods or services." Obviously, since the committee uses as a basis of its considerations under paragraph (1), page 70 of the report, "uncollected rights to income," and the right of the partnership which represented a contractual or other legal right to income for goods or services, it meant at the retirement or death of a partner where goods had been sold, but not paid for, and the consideration was represented by an unrealized receivable or the services had been rendered but the fee not paid at the time of retirement or death, these, along with defined appre ciated or depreciated inventory or stock in trade, as referred to in paragraph third on page 71, constituted the basis of section 736 of H. R. 8300. Here is a statement by the committee of its intent with respect to section 736 that what it was dealing with in this section of H. R. 8300 was certain things, and only these things, exclusive of actual purchase and sale of retired or deceased partner's interest in the partnership, and these things consisted of appreciated or depreciated inventory or stock in trade, and unrealized receivables and unrealized fees. All of these things were predicated upon an existing condition at the time of retirement or the death of a partner. In the second paragraph on page 71 of the committee's report, it states: "A decedent partner's share of unrealized receivables and fees will be treated as income in respect of a decedent." That is, in the case of a retired or deceased partner, if goods had been sold and there existed at the time an unrealized receivable, or if services had been rendered at the time but there existed in payment therefor an unrealized fee, that for 5 years, under subparagraph (A) of paragraph (1) of (a), section 736, the payments when received for a period of 5 years would be treated as income to the recipients, but after 5 years these limited sources of income as enumerated above would no longer be taxable to the recipients under ordinary income tax rates, but would be taxable to the remaining partners without the right of deduction as to amounts paid to the designees of a deceased partner or to a retired partner. This is made again manifest by (E) at the bottom of page 71 of the report, in which it is stated, in referring to section 736: "When a partner retires or payments are made to the estate or heir of a deceased partner, the amounts paid may represent several items. They may, in part, represent the withdrawing partner's capital interest in the partnership; they may include his pro rata interest in unrealized receivables and fees of the partnership and its potential gain or loss on inventory." Again, on page 72 of the report, among other things, the committee stated: "For this purpose payments for a 'capital interest' do not include amounts attributable to a partner's interest in unrealized receivables and fees, amounts paid for substantial appreciated or depreciated inventory, and amounts paid for goodwill in excess of its fair market value." The committee further states: "A different treatment is provided for the portion of payments to a withdrawing partner which is not made in exchange for capital interest of such partner. Such payments are treated as distributive share of partnership income to the withdrawing partner. Thus, they are taxable to the withdrawing partner in the same manner as if he continued to be a partner and are excluded in determining the income of the remaining partners." This is, under the bill, permitted for a period of 5 years, and thereafter the remaining partners, without a purchase or sale, are taxed at ordinary income-tax rates, and without the right of deduction with respect to such unrealized receivables and fees and appreciated or depreciated inventory or stock in trade. Section 736, undoubtedly, recognizes the rule that the property, of whatever character, which becomes part of the estate of a deceased for estate-tax purposes, is property owned by the deceased at the time of his death. Manifestly, this section recognizes the contractual ownership of a deceased partner in unrealized receivables and unrealized fees and appreciated or depreciated inventory or stock in trade at the time of death, and that, therefore, these items would become a part of the estate of the deceased and would be subject to estate tax. In other words, this section is dealing with items that are owned, or in which the deceased partner has a contractual right at the time of his death. All of this becomes clear in the statement of the committee, second paragraph, page 71: "A decedent partner's share of unrealized receivables and fees will be treated as income in respect of a decedent. Such rights to income will be taxed to the estate or heirs when collected, with an appropriate adjustment for estate taxes." Thus, it is apparent that the plain intent of the committee was to deal with a partnership having capital or assets, or both, and that the intent was to separate specifically unrealized receivables and unrealized fees, as defined above, and appreciated or depreciated inventory or stock in trade, from the assets of the partnership, which would be the subject of a purchase and sale. This memorandum, however, deals, not with a partnership possessing capital or assets, or both, but only with a personal service partnership that possesses neither capital nor assets. With respect to unrealized receivables or fees, in the absence of subparagraph (A) of paragraph (1) of (a), section 736, such items would be treated as part of the assets of the partnership and would be the subject of purchase and sale. Subparagraph (A) changes the situation for a period of 5 years. This memorandum, however, treats only with distributions from a personal service partnership having neither capital nor assets, of future unearned contingent profits, which would eventuate, if ever, following the retirement or death of a partner. They would have no relationship to a transaction that occurred prior to the retirement or the death of a partner. They would not constitute, under the definition and discussion of the committee, unrealized receivables or fees, and, naturally, could not refer to appreciation or depreciation of inventory or stock in trade, since such a partnership would have no inventory or stock in trade. Clearly, if personal service partnerships, having no capital and owning no assets, were covered by section 736 and section 751, there would be a plain discrimination between such partnerships and those having capital and assets, because, in the case of the latter, the partnership agreement could provide for the payments of unrealized receivables and unrealized fees and appreciated and nonappreciated inventory or stock in trade, for a period of 5 years with the right of the remaining partners to deduct from the income of the partnership arising from such sources, amounts paid to the recipients, and then provide, at the end of 5 years, a purchase and sale of the retired or deceased partner's interest. Thus, after 5 years, where the remaining partners could not deduct payments to the retired partner or deceased partner's estate, they would, in turn, get the assets that belonged to the retired or deceased partner, whereas, with respect to a personal service partnership, without capital or assets, there could be no sale, since there is nothing to sell and the remaining partners would pay income taxes at ordinary income-tax rates on future contingent unearned profits for the period of the agreement. Manifestly, this would be not only unsound but very unfair. The purpose of this memorandum is neither to evade nor avoid taxes. Its purpose is solely, with respect to any payments of future possible contingent profits earned, if ever, after the retirement or death of a partner by a personal service partnership having no capital nor assets, to establish that, under those circumstances, income tax at ordinary income-tax rates should be paid by the recipients of such future contingent profits, and not by the remaining active partners. This is in line with the realities with respect to such a partnership and according to the well-established law of this country for the following reasons: In the case of a personal service partnership having neither capital nor assets, there can be: (1) No sale of the interest of a partner in a personal service partnership, having neither capital nor assets. Bull v. United States, 295 U. S. 247, 79 L. Ed. 1421, 1426. Whitworth v. Commissioner, 204 Fed. (2d) 779, 783 (C. C. A. 7th), Cert. denied, 98 L. Ed. 64. Boyd C. Taylor Estate, 17 T. C. 627, Decision 18,560. Affirmed, 200 Fed. (2d) 561 (C. C. A. 6th), (on authority of Bull v. U. S. supra). (2) Future unearned speculative profits are wholly contingent and cannot be income or property at time of death or retirement. United States v. Safety Car Heating and L. Co., 297 U. S. 88, 80 L. Ed. 500, 504, 507. North American Oil Consolidated v. Burnet, 286 U. S. 417, 76 L. Ed. 1197, 1200. Commissioner v. Oates, 207 Fed. (2d) 711, (C. C. A. 7th), affirming 18 T. C. 570. (3) No goodwill attaches to the person of a partner in a personal service partnership. M. M. Gordon, et al. v. Commissioner, 9 T. C. 203. Decision 17,547 (M). Entered March 14, 1950. The Danco Co., 14 T. C. 276, Decision 17,503. John Q. Srunk v. Commissioner, 10 T. C. 293, Decision 16, 253. Providence Mill Supply Co. 2 B. T. A. 791, 793. Northwestern Steel and Iron Corp. 6 B. T. A. 119, 124. (4) To include such partnerships in the proposed sections would violate the "claim of right" doctrine. North American Oil Consolidated v. Burnet, 286 U. S. 417, 424, 76 L. Ed. 1197, 1200. Commissioner v. Wilcox, 327 U. S. 404, 408; 90 L. Ed. 752, 755. In re Lashells' Estate, 208 Fed. (2d) 430, 435. (C. C. A. 6th). December 4, 1953. (5) The contingent right to future contingent income or profits is not a capital asset. (See cases under point (2) supra.) It is apparent from the foregoing that if personal service partnerships having no capital or owning no assets should not be covered by sections 736 and 751, that to prevent misunderstanding and confusion, the amended paragraph (B) as set out on page 1 hereof should be adopted. Respectfully submitted. KANSAS CITY, MO. HOWELL, JACOBS & HOWELL. The CHAIRMAN. Mr. Vander Ark. Sit down and be comfortable and identify yourself to the reporter. STATEMENT OF JOHN A. VANDER ARK, MANAGING DIRECTOR, NATIONAL UNION OF CHRISTIAN SCHOOLS Mr. VANDER ARK. Mr. Chairman, my name is John Vander Ark. I am managing director of the National Union of Christian Schools with headquarters in Grand Rapids, Mich. I shall hereafter refer to the organization which I represent as "The National Union." The National Union is a union of educational organizations in 21 States of the United States, which are corporations organized and operated exclusively for educational purposes within the definition of section 101 (6) of the Internal Revenue Code. Contributions to these organizations and to the National Union itself are deductible under sections 23 (O) and (Q). None of the organizations is endowed. The constituency of the school organizations which form the National Union are primarily members of the Christian Reformed Church in America, although members of other Reformed and Presbyterian groups are among its supporters. The avowed purpose of our member societies is to set up and operate primary and secondary day schools which integrate the principles of the Reformed faith with the curricula in the respective schools. While the Christian Reformed Church, as a denomination, is committed to the principle underlying these Christian schools and does give it moral and financial support, the church itself does not own, operate or control them. Now, the rationale for this distinction between the church and school has philosophical and theological implications, which are not pertinent to this summary. We emphasize this distinction for it has an important bearing upon the problem which we are presenting for your consideration. This separation of church and school requires the setting up of separate organizations comprised of church members who subscribe to this principle. The National Union expresses its hearty approval of section 170 of H. R. 8300, which increases the charitable contribution limit for individuals from 20 percent to 30 percent, the additional 10 percent to be allowed with respect to contributions to educational institutions, and so forth. We are also in hearty agreement with the reasons for this change, as stated in the report of the Ways and Means, namely, that "this 45994-54-pt. 3- -22 www amendment is designed to aid these institutions in obtaining the additional funds they need, in view of their rising costs. ***" We feel, however, that the full effect and benefit of this amended provision will not be realized by the contributors to National Union schools unless and until the definition of "contribution" is broadened to include amounts contributed by parent members which are now designated as "tuition" payments or are determined to be such by the Internal Revenue Service. Just for interpretation, the visible means of support of these Christian schools comes from tuition, church offerings and individual gifts. Now, the National Union urges your committee to give consideration to this change in the Internal Revenue Code for the following reasons: 1. There is no standard by which tuition in our schools can be determined with any degree of uniformity. In some schools it may cover 50 percent of the operating costs; in others a somewhat higher percentage. On the other hand, some of our schools have no designated tuition rates at all but rely solely on pledges from supporters, parents, and nonparents alike. In some cases, where the support comes from the members of a single church in the area, the entire operating cost of the school may be raised by freewill offerings designated for the school. You may ask why tuition? Our second reason : 2. Where tuition systems are in effect, they are designed primarily as a guaranty to the school board of some measure of regular income. In case of inability to pay the stated amounts, parents pay what they can and the slack is taken up by other supporters or by the churches as a benevolence project. Pupils are not barred because of the nonpayment of tuition. 3. Tuition rates are, in effect, suggested minimum contributions for parents. In other words, they are not so much assessments as suggested payments. Human nature being what it is, without some measure of guidance, some parents might be inclined to shirk their responsibilities. 4. Taxes for the support of public schools are deductible from taxable income of parents and nonparents alike. The tuition payments made by parent supporters of Christian schools, the establishment of which relieves the community of part of its tax burden, are not deductible. Christian school supporters pay both taxes for the support of public schools and tuition for the support of their own schools. And, I may add that our parents pay their taxes for the support of public schools willingly. Both payments are, essentially, for the same purpose, yet are treated differently under the tax law. 5. Here we are very much in common with other church groups that operate their parochial schools, but the problem is that contributions by Catholic and Lutheran parents, for example, for the operation of parochial schools which are owned, operated, and controlled by the church, are made to the one integrated church organization. Any attempt at a segregation or determination of the amount of such contributions which could be deemed to constitute tuition would be an extremely difficult if not impossible administrative task for the Internal Revenue Service. Nonparochial Christian schools, such as those in the National Union, should not be placed at a disadvantage |