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NEWS RELEASE

The Treasury Department today announced the results of its review of the proposed regulations issued last August under sections 482 and 483 of the Internal Revenue Code. Regulations were proposed at that time to adjust the existing rates to more closely approximate the higher market rate of interest. Although final regulations will not be issued before July 1, 1981, the Treasury Department made the announcement in response to numerous inquiries by taxpayers concerning possible changes in the imputed interest rates and the effective date provisions.

In general, the final regulations will provide (i) that the minimum interest rate that must be charged under section 483 to prevent imputed interest is 9 percent simple interest and (ii) that the minimum rate that must be charged under section 482 to prevent imputed interest is 11 percent simple interest. These rates are unchanged from the proposed regulations. However, if the literal terms of both sections 482 and 483 apply to a transaction, then the minimum interest rate to prevent imputed interest will be 9 percent simple interest.

The final regulations under section 483 will, in general, provide that unless a contract for the sale of property provides for at least 9 percent simple interest on deferred payments, a rate of 10 percent, compounded semiannually, is imputed. Under the present regulations, the comparable rates are 6 and 7 percent.

The final regulations under section 482 will, in general, provide that the IRS can impute 12 percent simple interest on loans between commonly-controlled trades or businesses unless the taxpayer charges a rate between 11 and 13 percent or establishes that a different rate would be an appropriate arm's length rate. Under the present regulations, the comparable rates are 7 percent and 6-8 percent.

Many comments on the proposed regulations expressed concern that by providing a higher rate under section 482 than under section 483, sales of property to family members or other related parties would be subject to the higher rates of section 482, thus providing a possible disincentive to sell property, such as a family farm, to family members. final regulations will eliminate any such possible

The

disincentive by providing that, in the event the literal terms of both section 482 and section 483 apply to a transaction, section 483 will override section 482. Thus, the 9 percent minimum interest rate provided under the section 483 regulations will be sufficient for all sales of property subject to section 483, including any sales of property to family members potentially subject to section 482.

Other comments indicated a misunderstanding of the manner in which section 483 operates. Specifically, many comments assumed that if interest is imputed under section 483, a greater total amount must be paid by the purchaser for the property. As illustrated below, this is not how section

483 operates.

Asssume A sells a farm to B for $1 million and that the contract of sale provides that B shall pay A $100,000 each year for 10 years. Since no interest is provided for in the contract, the contract fails the 9 percent minimum rate (i.e., test rate) established under section 483. As a result, some portion of each $100,000 payment will be considered interest for federal tax purposes. The remaining portion of each $100,000 payment will be considered to be a payment of principal. The amount of each payment considered to be interest will reflect 10 percent interest, compounded semiannually. (Tables and instructions are provided in the regulations to determine this amount). The effects of the application of section 483 are the following:

1.

2.

3.

B still pays A only $1,000,000 in 10 installments of $100,000 each;

A must report the amount considered to be interest as interest income on his federal tax return and B is allowed an interest deduction for the same amount;

A's gain on the sale and B's basis in the property
will be based on the portion of the $1,000,000
representing principal and not on the entire
$1,000,000. Thus, A will have less gain (or more
loss) on the sale and B will have a lower basis in the
property than if the entire $1,000,000 were deemed
principal.

This example illustrates that only the federal income tax consequences of the transaction has been changed. The contract between the parties continues to define all matters other than the federal income tax consequences of the transaction.

In general, the effective date of the final regulations under sections 482 and 483 will be July 1, 1981. However, special "grandfather" rules will apply under the section 482 regulations to interest paid pursuant to a non-demand loan or advance entered into on or after July 1, 1981 but pursuant to a binding contract entered into prior to August 29, 1980. Also, special "grandfather" rules will apply under the section 492 regulations to payments on account of a sale or exchange of property entered into on or after July 1, 1981 but pursuant to a binding written contract (including an irrevocable written option) entered into before September 29, 1980.

Senator GRASSLEY. Now, I would like to call to the witness table, Neil E. Harl, Charles P. Curtiss, distinguished professor, Iowa State University, Ames, Iowa and Paul Hasbargen, professor of agricultural economics, University of Minnesota.

Senator Durenberger, I am sure that you would like to introduce Paul.

Senator DURENBERGER. Thank you, Mr. Chairman.

I would start by saying I am pleased that Paul is here. We have, besides being blessed with 92,000 family farms, we are blessed at our university with a variety of talents, as I am sure you are in your State, Mr. Chairman, of people who have been in the public service business probably longer than we, with a commitment to the family farms.

Paul Hasbargen and several of his associates there have over the period of time that I have been in public service, made immense contributions to the formulation of public policy in our State, in the area of agricultural economics.

I think he is as important a witness as we are going to hear as we do our oversight of the Internal Revenue Service.

I am pleased that he had the time to be here today.

Senator GRASSLEY. Mr. Harl is distinguished by his publications on this general subject of State taxes, but most recently, because of writings he has done since the 1976 estate tax law was passed, and you know, in complimentary fashion, I think it can be said that a lot of people have made some judgments of how they ought to plan their estates based upon the writings of Neil Harl.

I would like to ask Neil if he would start.

STATEMENT OF NEIL E. HARL, ACCOMPANIED BY CHARLES F. CURTISS, PROFESSORS, IOWA STATE UNIVERSITY, AMES, IOWA

Dr. HARL. Thank you, Mr. Chairman, Senator Durenberger.

I am pleased indeed to be here, and I appreciate the opportunity to appear before this subcommittee and to provide commentary. I have a one-page summary, which is a bit more reasonable than the 22-page longer piece which is submitted for the record.

My written testimony is divisible into three parts basically, on use valuation, and then I will conclude with some comments on the imputed or unstated interest rules.

The first part of the written testimony is a brief examination of some policy considerations.

The second part of the written testimony is a listing of areas where technical problems exist, some of which have just been resolved, apparently, so we won't need to spend much time on those items.

The third part of the written testimony involves a look at three areas where we think more fundamental changes may be worth considering.

In mention of the policy side, and this will be brief indeed, any substantial change in the scope of coverage or in the quantitative benefit amount available, we think probably should be undertaken only with adequate attention to the policy implications. Some of those have been touched on in earlier testimony this afternoon.

The first is the potential of inducement for mere investors to acquire land to obtain the tax benefit. This is what we call the gate that is needed to preclude mere investors of all types from taking advantage of a benefit targeted for family farms and ranches. The second is the problem of encouraging older individuals to retain land until death so that in at least some families older individuals see an advantage in not making transfers during life. The third is the tendency for the benefit to be capitalized into land values.

The fourth is the fact that the greatest benefit tends to accrue to those with the largest estate, not just looking at the $500,000 maximum reduction of gross estate, but the fact that the benefit from the $500,000 amount is greatest for those in the 70-percent tax bracket.

Finally, the expected effect on farm firms.

Most of these are in the nature of long-term considerations. We cannot offer to you quantitative estimates of these policy matters based upon our 4 years of experience.

We think however, that we are moving into a time when we will be able to do more empirical research in this area.

Special attention is directed to the areas in the law that need technical attention. We identify four. I would like to add one more, for the record.

The first two have been addressed by the Internal Revenue Service today including the qualified use test which has essentially precluded the use of cash rental arrangements even between family members.

As I understand the statement of the Internal Revenue Service, they are saying that section 2032A(b)(2), would be interpreted to permit the qualified use test to be met by members of the family, as well as by the decedent-to-be.

I think this is a reasonable interpretation. The major question I have is that this matter ought to be conveyed to attorneys and taxpayers as soon as can be done in light of previous Internal Revenue Service policy. There are matters in litigation and there are matters in planning for which this is a very vital concern. So, I would simply indicate that the sooner the better, in terms of getting that information into the hands of users.

The second technical area is the present interest test. I guess I have some concerns remaining there. Essentially, what we are talking about is a problem that is almost totally limited to the use of the sophisticated will and trust.

Ironically, this is the kind of trust we have been encouraging people to use for the past 20 years.

We have estimated that probably 95 percent of the wills and trusts of the fairly sophisticated type drafted in the past 20 years, probably wouldn't meet the present interest test, as we understand that test in the form of letter rulings.

So, again, if there is a change of policy, we think that should be communicated as quickly as possible to users. Otherwise, there seems to be little recourse other than a massive recall, and I mean massive, of sophisticated wills and trusts that have discretionary powers within them, discretionary both with respect to income and with respect to principal. Moreover, if we must do that, it will

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