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of the property over the amount of original consideration furnished for each year the spouse materially participates in the business and the eligible jointly-owned property is used in the business. The small businessman is concerned about the uncertainty involved in being able to prove that his or her spouse has been materially involved in the management and operation of the business and, furthermore, to prove that he or she was materially involved in a particular year. For estate tax planning purposes, this must be clarified to avoid challenges upon examination.

Let me reiterate the primary concerns of the small businessmen I serve.

to have Congress help them in the following areas:

They wish

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• Provide for separate tax rates for gifts and transfers at
death. The need to provide a greater incentive to make
lifetime gifts is evident,

Do away with the administrative headache of having to file
gift tax returns on a quarterly basis. A combined gift tax
return and income tax return may be administratively more

appropriate,

The $3,000 annual gift tax exemption on amounts given to a
particular donee must be raised to a higher amount to

encourage making lifetime gifts of property,

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Consideration should be given to increasing the minimum

marital deduction from $250,000 to perhaps $500,000 to
reduce the tax burden on small estates, and

Clarification is needed to that part of the law in which a

spouse shares in the jointly-held property if he or she

materially participated in the operation or management of

the business.

I appreciate the opportunity to address you gentlemen this afternoon on behalf of my small business clients. I hope these concerns can be addressed by Congress in the near future as I believe all are consistent with the overall goal of assistance to small business, stimulation of production, and capital formation and retention.

STATEMENT OF RUSSELL J. SUDEITH, JR., ATTORNEY AT LAW, FELHABER, LARSON, FENLON & VOGT, ST. PAUL, MINN.

Mr. SUDEITH. My name is Russell J. Sudeith, Jr., and I appreciate being able to be here to testify. I'm acquainted with the business problems of small business owners because of my firm's law practice where we represent a large number of small businesses. When you do that, you have the opportunity not only to aid them in their buinesses, but you get to know your clients personally and so you are involved in their estate planning and the probates of their estates when they die, and so forth. Also, during the last 2 years, I've had the opportunity to chair the Small Business Council for the St. Paul Chamber of Commerce and that has been an eye opener in terms of the problems small businesses have. I have submitted my testimony in writing and so I will try to summarize it here. It goes without saying that in the past few years, taxes, energy costs, inflation, Government regulations, and other problems have seriously hurt small businesses. The effect of estate taxes has also been, in some cases, very troublesome. Small businesses are in a situation where inflation escalates their value. Many owners of small businesses sacrifice financially themselves so that capital will be available for their businesses. This results in increased values which trigger estate taxes on the death of the owner. One feature of the proposed Omnibus Small Business Act would increase the State tax exemption from $175,000 to $500,000. In my opinion, this would go far in solving many of the problems created by the present estate tax law. In many cases, estates close to the $500,000 level are the least able to afford estate taxes, and all of the capital of that business and the family is needed for the business to survive.

An increase in the unified credit which would allow a $500,000 exemption, not only would reduce the amount of estate taxes due, but would also avoid some other problems that are encountered when an owner of a small business dies. These have to do with delays in probate and also in substantial expenses that are incurred in probating estates of this kind. Small businesses are very difficult to value. If you review the regulations under section 2031 of the Internal Revenue Code, and the various cases that have been developed under that section, you find that there are a large number of complicated and difficult factors that must be taken into account in valuing the business. Due to these complexities, there often develops a controversy between the representative of the estate and the Internal Revenue Service or the State taxing authorities. The estate must often hire experts to appraise the business and, quite often, the experts and the tax authorities disagree on the valuation. This can result in a long, involved probate, sometimes taking years. During this period of time, the cost incurred for appraisers and legal fees are substantial. Appraisal fees, for example, even for a small business, can run from $5,000 to $10,000 or more, and, may be completely disregarded by the Internal Revenue Service. This process often results in hardship for the heirs, because distribution of the business out of the estate is impossible until these matters are taken care of. Quite often, then, as a result the capital of the business is utilized not only to pay estate taxes, but these expenses that should not have to be incurred. I'm not suggesting necessarily that the valuation procedures are incorrect, but what I'm suggesting is that the exemption

to $500,000 would not only save taxes, but would shorten the probate procedure.

A typical estate of a small owner of a business or an owner of a small business could easily be in the range of $750,000 to $1 million. Estates of this size are not at all uncommon today and very often there are virtually no liquid assets with which to pay taxes. A substantial portion of the total estate value may be the small business itself. As an example, assuming a small business owner died in 1981-when the present unified credit reaches its maximum-and that owner had a surviving spouse, the owner's estate would pay approximately $60,000 in Federal estate taxes on the $750,000 estate, and about $100,000 on a $1 million estate. However, if the owner who died did not have a surviving spouse and the estate could not take advantage of the marital deduction, the taxes on such an estate would be $180,000 for the $750,000 estate, and $265,000 on a $1 million estate. An increase in the credit to allow a $500,000 exemption, would substantially reduce the taxes in cases of this type. In addition, the controversy over valuation may not develop and the probate of the estate could be completed in a much shorter period of time.

I was also going to testify-and there is testimony in my written remarks that I am in favor of an expansion of section 2032A of the Internal Revenue Code to defer or exempt part of the estate tax on small businesses rather than just deferring or exempting the estate tax on the real estate that is utilized in those businesses, as is the present law.

Second, I intended to testify in favor of an increase

Senator BAUCUS. Could you explain that? I don't understand that, that last point you made.

Mr. SUDEITH. The present law provides that real estate that is used in a business will not be valued at its highest and best use, but will be valued as it is valued as an asset used by the company. This often results in a lower valuation and up to $500,000 of that value can be either deferred or forgiven, if the real estate is kept in the business and used by the business for a period of years. If it's used for 15 years, the tax is exempted. If it's used for between 10 and 15 years, there is a progressive exemption. And if it's not used for at least 10 years, then, the tax is picked up when it is finally sold.

Senator BOSCHWITZ. That is the provision to permit the passage of family farms, basically.

Mr. SUDEITH. The same provision applies to farms, except in the case of farms, the provision applies to the entire valuation of the farm, as I understand; whereas, in other types of small businesses, it only applies to real estate, not the other business assets.

And, last, I was going to testify-there is testimony in my written remarks in favor of the increase in the annual exclusion for gift taxes. Both of the other panelists here will testify on that issue, so I will defer to them on that.

Thank you very much for the opportunity to appear.
Senator BAUCUS. Thank you, Mr. Sudeith.

[The prepared statement of Mr. Sudeith follows:]

STATEMENT BY

RUSSELL J. SUDEITH,

ATTORNEY-AT-LAW

JR.

FELHABER, LARSON, FENLON & VOGT, P.A.
WEST 1080 FIRST NATIONAL BANK BUILDING
SAINT PAUL, MINNESOTA 55101

TESTIMONY BEFORE SENATE SELECT COMMITTEE ON SMALL BUSINESS

October 13, 1980

Small business owners have experienced increasingly difficult times in recent years. The ability to raise capital for commencement of a new business or expansion of a present business in many cases has been impossible. Energy costs and inflation have placed a heavy burden on small businesses. governmental regulation has become costly and more time consuming.

Contending with

The effects of estate taxes on small businesses are also apparent from the wealth of information that has been gathered by this committee. Inflation artificially escalates values. Many business owners sacrifice financially so that capital can be retained in the business to help it grow. Values of businesses are thereby increased to levels where the death of the owner triggers estate tax liability and causes severe hardships for the business and/or the heirs of the owner.

One feature of the proposed Omnibus Small Business Act

is the increase of the estate tax exemption from $175,000 to $500,000. In my opinion, this increase would go far in solving

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