Senator GRASSLEY. The next panel consists of Bob Furleigh, a farmer from Clear Lake, Iowa, J. D. Luse, Duff Farm Management Service, Lebanon, Ind., Philip Ridenour, Cimarron, Kans., and David J. Hutton of Hutton, Kennedy & Neaton, Minneapolis, Minn. Are all of you here?

OK. I guess I would like to have you proceed in the order that I introduced you. Mr. Furleigh, Mr. Luse, Mr. Ridenour, and Mr. Hutton. I would like to have you go in that order and I would also like to remind you, so you won't have to ask for permission to do so, your statements will be printed in the record if you submit them and that is your desire.

We would appreciate it if you would summarize. The blue light is when your time starts, the yellow light is when you have a minute left and the red light and the bell simultaneously signify that your time has expired.

Bob, would you proceed please?

STATEMENT OF ROBERT FURLEIGH, CLEAR LAKE, IOWA Mr. FURLEIGH. Thank you, Mr. Chairman, for allowing me to appear. I do commend the subcommittee on your willingness to deal with these issues.

My name is Bob Furleigh, from Route 2, Clear Lake, Iowa. I am a genuine farmer. I raise cattle, hogs, field crops, vegetables. I am not sure if all the witnesses were requested to leave their shoes in the hallway or not. But, it apparently applies to some of the witnesses.

I farm in north central Iowa. I am here to describe the effect of the recent administrative regulation by the IRS. It has been referred to many times. I am not sure even if my testimony is necessary at this point, but I will try to summarize on this matter. My father died this winter. We had a family-size farm. By the way, I think you have copies of my testimony, too. I would like to request that they be placed in the record.

Senator GRASSLEY. Yes, it will appear in the record.

Mr. FURLEIGH. It comes at a time when it is going to be tough to make this payment beyond what our plans were from having read Dr. Harrel's book and consulting with our attorneys, and assuming that we were eligible for the use tax or use valuation, under 2032(A).

But, at any rate, we suffered a shock after his death in finding that there was indeed a ruling that disallowed the use valuation where we were using cash rent with my father, prior to his death. There has been a great deal of increase in cash rent in our part of the State, and I suspect, across the State of Iowa, and the States of Illinois and Iowa, both.

It was plain to me, that Congress, in enacting the 1976 Internal Revenue Code wanted to preserve the family farm or small business by providing for use valuation, to a limited extent, where a commitment is made by all the heirs of the family farm or small business to a continued operation of that farm by the family, for at least 15 years.

As you probably know better than I, there is an extended list of conditions or tests surrounding the use valuation, including the 15year tax lien against the property, in case the farm is sold by the

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family or rented to someone else outside the family during the 25 years.

If it were not continued as a family farm, there would not only be a recapture of whatever estate tax might have been saved, but in case of a later sale, whatever gain might be experienced would be computed on the lower basis of the use valuation, because an obvious double penalty for early disposition. Dr. Harl, I was pleased to note, mentioned this as a technical factor he hoped the Senate could or the Congress could deal with.

As I understand it, 25 percent of the estate must be real estate. 50 percent must be farm or business property in general. The farm must have been operated and material participation by a decedent or a member of the family during 5 or the last 5 years prior to his death.

The farm or small business valuation cannot be reduced by more than $500,000.

Now, the use valuation provides for capitalizing at typical cash rent, as we have already heard. It doesn't usually make interest in our part of the State these days, farm land, so that utilizating the use valuation would normally result in a lower valuation for estate tax purposes.

I haven't tried to describe all the provision in precise legal terms or even list the conditions and procedure. I am only a farmer, not a lawyer. But, I do have a copy of the section 2032(A), the IRC, and it refers repeatedly to material participation by the decedent or members of the family and other places it says "and or."

Somehow or other we came up with a regulation that might as well forget the part with "or," I believe, because at least in my opinion, it falls back on the active participation of the decedent. Again, I admit to being probably being the least qualified person in this room to read and understand legislation, but that is the way it looks to me.

I should say that our attorney even cautioned us against using this as an option, because he said:

You must be sincere about continuing this, because of the penalties that occur should early recap, early disposition or change in operation bring about.

My wife said that I carried on a little too much in this testimony about establishing whether or not this farm in question was a family farm, Senator. So, I am not going to read this. I go through a period of 1971 ownership by the family and the family's participation. No one else farmed the farm during that 71-year period. I just want to make the point that this is not a quick move by an outside investor to achieve a tax shelter here.

I respectfully propose, Mr. Chairman, that this ruling is not consistent with the intent of your legislation and that you try to eliminate its effects some way that applies to section 2032(A). Maybe it has already been dealt with. I trust your judgment in that respect.

Senator GRASSLEY. We hope that the statement of the Commissioner and the Secretary, take care of your problem. I suppose that we need to follow up and make sure that there is a common understanding of what they are doing, but that is the way I interpret it as I understood it. Is that fair to say?

If it does, then a lot of the problems with a lot of people will be taken care of.

Would you stay at the table until the panel is completed? I may have some questions I want to ask each one of you.

The next person is Mr. Luse. I hope that is pronounced right. Mr. LUSE. Right.

Senator GRASSSLEY. Would you proceed?

STATEMENT OF JAY D. LUSE, DUFF FARM MANAGEMENT

SERVICE, LEBANON, IND.

Mr. LUSE. Thank you, Senator. I am a farm appraiser in central Indiana. I am a member of the American Society of Farm Managers and Rural Appraisers and have experienced making appraisals under 2032(A).

In some parts of our country special use valuation appears to be achieving its goal of relieving some of the estate tax burden from the family farm.

Those areas in which it is working are those in which renting farms for cash is common, so adequate comparable rental data is available.

However, areas of the country in which farm land is not typically rented for cash are having difficulty utilizing 2032(A).

The first point I wish to make is that under 2032(A)4(b)(2), the special rules documentation required of the executor, the executor must identify to IRS actual comparable property for all special valued property, and cash rentals from that property, if it is to be valued under paragraph (e)(7).

If the executor does not, all of the special valuation property must be valued under paragraph (e)(8).

The words "or all special evalued property" were not in the proposed regs., but only appear in the final regulations.

Agents in the field sometimes interpret that phrase to mean every little bit of miscellaneous land on the farm.

They then require the executor to attempt to find cash rentals of small miscellaneous parts of the farm that are of little value, and for which there is no rental market. Finding none, the agents ask the executor to value the farm under paragraph (3)(8).

In this situation, the estate should be allowed to value under (e)(7), the bulk of the land for which cash rentals are available, use (e)(8) on the remaining qualified property and use the fair market value on the miscellaneous parts of the farm.

There shouldn't be any problem with allowing the estate to pay tax based on the fair market value of portions of the property and allowing election special use value on the balance, recognizing, of course, that the threshholds to qualify would have to be met. The reason for this is that IRS is attempting to interpret paragraph (7), to be so restrictive that the estate is forced to go to paragraph 8.

Apparently IRS feels that paragraph 8 will not or should not provide the tax relief that paragraph (7) holds.

This committee needs to recognize the relationship between paragraph (7), and paragraph (8), and point out to the Treasury Department the need for the two paragraphs to contain some consistency.

IRS interprets the phrase in the law that says "the formula provided by subparagraph (a), shall not be used where it is established that there is no comparable land from which the average annual gross cash rental may be determined," to mean that the capitalization rate, based upon Federal Land Bank interest rates, as used in paragraph (7), would not apply in paragraph (8).

This is my second point. If you want paragraph (7), and paragraph (8), to have somewhat uniform impact upon farm estates in various parts of the Nation, then you need to see that the same Federal Land Bank interest rate is used as the capitalization rate in both paragraph (7), and paragraph (8), sections (a) and (b).

American agriculture includes many farm rental arrangements in various areas. There is considerable renting for cash in central Indiana, while next door, in central Illinois, nearly all rentals are share arrangements.

All of the various rental rental arrangements come down to the same thing, money. It matters not whether the land owner rents his land for cash or one-half of the crop and pays one-half of the seed fertilizer and chemicals or rents his range for dollars per animal unit. The owner converts all of that to money and so can any competent appraiser.

Since all rental arrangements reduce themselves to money, it is only fair and equitable to use the same capitalization rate to convert income into value under 2032(A).

If you want to treat all of the family farms in the Nation in the same way, then don't let the capitalization rate change in paragraph (7), to paragraph (8).

Thank you.

Senator GRASSLEY. Thank you very much.

Now, I would like to go to Mr. Ridenour. Before you start, I would like to say that Senator Dole, who is chairman of the full committee, had hoped to be here to welcome you, but he has been detained in the Agriculture Committee, and also, let me tell you that some informal sessions in regard to budget allocations as a member of the Senate Finance Committee.

He wants to express to you his regrets that he could not be here to welcome you.

[Senator Dole requests this statement appear in the record:]

PREPARED STATEMENT OF SENATOR BOB DOLE

INTRODUCTION OF PHILIP D. RIDENOUR, CIMARRON, KANS.

Mr. CHAIRMAN: I am pleased that Mr. Philip Ridenour of Cimarron, Kansas, is here today to testify before the Subcommittee on problems that have arisen in connection with the regulations governing special use valuation of farm property. Mr. Ridenour is a partner in the law firm of Ridenour and Knobbe in Cimarron. He has had considerable experience in working with the special use valuation and the regulations designed to implement it, and I understand that he will indicate some of the particular problems of farm estates in Kansas, including the approach taken by local agents of the Internal Revenue Service. It is clear that estate tax practitioners have had considerable difficulty with the approach the Service has taken to implementing this law, and I appreciate the fact that Mr. Ridenour has taken the time to come to Washington to discuss these problems with us.

STATEMENT OF PHILIP D. RIDENOUR, CIMARRON, KANS. Mr. RIDENOUR. Fine. Thank you, Senator Grassley.

Senator, I practice law in western Kansas. I might add, extreme western Kansas. My testimony today is going to draw on our experience in filing nine estate tax returns which have elected use value or protective use value elections.

I would like to take a look at some of the problems we have discovered in the local Kansas district.

Generally, it is our feeling, in our office, that the national office has drafted a number of restrictions through adoption of the regulations which make the election extremely difficult.

I suppose the best analogy I could come up with would be to analogize it, perhaps, to the marital deduction section. Qualification for use value under the regulations would be akin under the marital deduction section to proving that your priest, rabbi, or minister was properly ordained or that the justice of the peace had been elected by the requisite number of duly qualified electors. Turning to the outline, my first point under national office problems deal with cash leases. You have heard a great deal of those today. To arrive at the cash rental value, the regulations currently require that only cash leases may be used. There aren't any in our

area.

We can extrapolate, though, I think to anyone's satisfaction what the cash rental value is based on a crop share rental. Unlike what Secretary Chapoton said this morning, that is not a complicated problem at all.

In every county in Kansas, at least, the county agents have a history of production. Let's take almost any crop, wheat, corn, milo, and soy beans that our county produce; we have a 50-year average of the yields of those crops. In the case of soy beans, they have obviously not been grown that long in our part of the country, but nevertheless, there is a long average.

It is a very simple matter to rely upon the county agents' averages and elevators' averages on their records as to what the value of a bushel of one of these commodities has been for several years. Point No. 2 deals with lease studies. The regulations prohibit areawide averages. There is an excellent study that has been compiled in the State of Kansas by Kansas State University dealing with average areawide rentals. It is an excellent study. It is very well done and under the regulations we are forbidden and prohibited from using that.

Points three and four on equity interest and present interest have been taken care of apparently by the Treasury's announcements this morning.

Paragraph 5 of my outline involves what is probably the silliest requirement of the use value regulations and that is the requirement that a corporation officer, director, stockholder, or employee must have an arrangement with the corporation regardless of the fact that he may be employed fulltime and solely employed and be the only material participator in the corporation. In the absence of some sort of provable formal arrangement, he is disqualified from electing use value, and there is deemed to be no material participation by the decedent or his family.

No. 6, I think though, is probably the most serious problem that we have observed and that is guidance from the national office. The 1976 reform act is now 41⁄2 years behind us. To date we have