The size of the tax burden can also be appreciated by its comparison with other life insurance company expenses of doing a pension business. Group annuity contracts, to use one example, constitute a widely used medium for funding pension plans, and one for which expenses are shown separately in the published statements of life insurance companies. For such contracts, it is estimated that under current law the Federal taxes on investment income from funds arising from pension plans will exceed the total of all expenses (other than taxes) incurred in the servicing of such contracts.

This situation is featured in sales literature issued by corporate trust companies who seek pension trust business in competition with life insurance companies. For many employers it has been a compelling argument which has led them to fund their new pension plans through a bank trustee or to change the method of funding their existing insured plans. The many advantages of insured pension plans, as compared with uninsured plans not providing fundamental guarantees to employees and pensioners, may be lost solely as a result of such discriminary tax treatment.

The two most important agencies for funding private pension plans are bank trustees and life insurance companies. There is keen competition between them. Both this competition and the employers' freedom of choice are presently affected by this serious tax discrimination.

The discrimination against employees covered by contracts written by insurance companies was the subject of corrective legislation offered as a part of the Life Insurance Company Tax Act for 1955, as passed by the House. The bill provided for the ultimate exemption of the income earned on insured pension funds. These provisions were, however, deleted by the Senate Finance Committee, without prejudice to the principle involved, because there was insufficient time for hearings before the committee.

We urge that this discrimination be ended.

4. Profit-sharing plans with fixed benefit formula: section 401 (a)

As set forth in paragraph (4) of subsection (a) of section 401 of the Internal Revenue Code a stock bonus, pension, or profit-sharing plan meets an important requirement for qualification if the contributions or benefits provided under the plan do not discriminate in favor of employees who are officers, shareholders, persons whose principal duties consist in supervising the work of other employees, or highly compensated employees.

The current position of the Internal Revenue Service is that a pension plan may meet the test of nondiscrimination by considering either (a) the amount of contributions on behalf of the employees or (b) the amount of benefits provided for employees. However, in testing a profit-sharing plan, the Internal Revenue Service takes the position that only the amount of the contributions on behalf of employees may be considered in applying the nondiscrimination test, and not the amount of benefits to be provided as is permitted for a pension plan

This, it is possible to establish a qualified pension plan under which the contributions on behalf of the employees covered under the plan are a fixed percentage of compensation. Each employee then receives whatever amount of retirement income can be purchased by the money contributed for him. Pension plans of this type are commonly referred to as money purchase plans.

It is also possible to establish a qualified pension plan under which the benefits provided are a fixed amount per year of service or a fixed percentage of compensation. Because of the inherent advantages of the 'fixed-benefit approach almost all new pension plans are established on this basis and many of the earlier money purchase plans have been converted to a fixed-benefit arrangement. Nevertheless, either type of plan may currently constitute a qualified pension plan.

In the case of profit-sharing plans, however, the Internal Revenue Service contends that because the amounts to be contributed are indefinite the benefits provided under the plan cannot be considered definitely determinable and hence, the test of nondiscrimination must be based on the relationship between the contributions made on behalf of the employees covered under the plan and their compensation. This contention seems difficult to justify in the case of a profitsharing plan utilizing a definite contribution formula. Under such plans the contributions and resulting benefits are not subject to arbitrary determination but denied solely on the profits of the employer as must all other employee benefits depend for their ultimate support.

Neither a pension nor a profit-sharing plan can be nondiscriminatory in both the contributions and benefits it provides. Limiting the test of discrimination to

contributions restricts profit-sharing plans for all practical purposes to the money purchase type and makes unfeasible the socially more desirable fixed benefit type of plan. Consequently, the allocation of contributions under a profit-sharing plan invariably results in the following distortions typical of money purchase plans:

1. Because it costs more to provide a given amount of pension as the age of an employee increases, the money purchase arrangement results in older employees (whose need for retirement income is more urgent) being credited with smaller monthly pensions in relation to earnings than younger employees.

2. Similarly, female employees receive a smaller monthly pension in relation to earnings than male employees of the same age.

3. It is impossible to closely integrate the retirement benefits provided by the profit-sharing plan with social-security benefits. The introductory paragraph of Revenue Ruling 57-77 (I. R. B. 1957-9, 14) states as follows:

"A favorable advanced determination will not be rendered in the case of a trust forming part of an employees' profit-sharing plan which provides that contributions to the trust will be used to provide benefits allocated in proportion to the cost of providing units of retirement annuities in proportion to annual compensation where the cost of such units are dependent upon the sex and age of the respective employee participants in the year of allocation and purchase." A number of sound profit-sharing plans of the fixed-benefit or unit-credit type were established under the present law prior to the issuance of Revenue Ruling 57-77. The qualified status of such plans is now in jeopardy because they must meet each year the test of nondiscrimination based on the amount of contributions allocated on behalf of the employees covered under the plan. It is highly desirable that provision be made in the Internal Revenue Code for the continued operation of these plans on a qualified basis and for the establishment of new plans of the fixed benefit type.

To permit the qualification of profit-sharing plans in which the contributions are determined entirely by a definite formula applicable to current profits and are applied to provide nondiscriminatory benefits; and in particular, to permit qualifications of profit-sharing plans whose benefits are disbursed to employees as retirement annuities, where the amount of such retirement annuities, rather than their original cost, bears a fixed relationship to wage or salary, we recom mend that section 401 (a) (5) be amended by adding at the end thereof the following:

"A profit-sharing plan in which contributions are definitely determinable with reference to current profits and under which the benefits provided in each taxable year would not be considered discriminatory under this subsection shall not be considered discriminatory within the meaning of paragraph (4) merely because the contributions on behalf of the employees under the plan do not bear a uniform relationship to the compensation of such employees."

5. Qualification of annuity plans of life insurance companies

Section 403 (a) (1) of the Internal Revenue Code of 1954 provides that employer contributions to employee's annuities are not taxable to the employee until the benefits are actually received by him provided the employer's contribution is deductible under section 404 (a) (2) or provided it is made by an employer exempt from taxation under section 501 (c) (3). Purely by oversight the code fails to recognize plans of exempt organizations (other than organizations ex empt under section 501 (c) (3)) which, of course, do not take deductions, and of life insurance companies taxed under subchapter L of the code and not entitled to take deductions for compensation to their employees under section 404 (a) (2).

Obviously, annuity plans which meet the requirements of section 401 (a) of the Code and which are provided for emplovees of life insurance companies fall within the purview of section 403. The Internal Revenue Service has ruled very properly that contributions to an employee's annuity by a life insurance company shall be included in the employee's income only as benefits are received. (I. T. 3715, 1945 C. B. 62.)

Even though this ruling administratively provides safeguards for pension plans of life insurance companies, the Code should be specific on this point. Certainly the concept of deductibility of employer's contributions has of itself no real relevance to the taxation of the employee, and in fact might be eliminated entirely from section 403 (a) (1). The following is offered as one method of amending the Code to correct the earlier omission.

Section 403 (a) (part to be omitted in brackets; new language in italic) : "(1) GENERAL RULE.-Except as provided in paragraph (2), if an annuity contract is purchased by an employer for an employee [under a plan with respect to which the employer's contribution is deductible under section 404 (a) (2),] under a plan which meets the requirements of section 401 (a) (3), (4), (5), and (6), and as to which refund of premiums, if any, are applied within the current taxable year or next succeeding taxable year toward the purchase of such retirement annuities, or if an annuity contract is purchased for an employee by an employer described in section 501 (c) (3) which is exempt from tax under section 501 (a), the employee shall include in his gross income the amounts received under such contract for the year received as provided in section 72 (relating to annuities) except that section 72 (e) (3) shall not apply."

6. Investment in group annuities under profit-sharing plans without the intervention of a trust—Sections 403 and 404

Under sections 403 and 404 of the Code an employer may establish a pension plan meeting the conditions of section 401 by directly purchasing group annuity contracts from an insurance company without creating an intervening pension trust. It is obvious in cases of group annuity plans that the need for a separate trust agreement and the additional cost imposed by the creation of the trust entity is not present, and the Code recognizes this specifically. The same is true of group annuity contracts designed for use in a profit-sharing plan for pension purposes. However, in this case the Internal Revenue Service has never permitted the qualification of a plan without an intervening trust. There has always been a question as to whether the Code itself requires the establishment of a trust in the common-law sense in any case so long as proper safeguards against discrimination and against use of funds for the benefit of the employer are established. The legislative history of the pension and profitsharing plan provisions of the Code and court opinion on this subject all support a liberal interpretation of the term "trust" in this context. The Internal Revenue Service has, however, always insisted upon the establishment of a trust recognizable under State law, if the profit-sharing plan is to be qualified. Therefore, even though present law is subject to the interpretation that a nontrusteed profit-sharing plan would be permissible, it is not so administered and legislative relief is necessary.

The growth of profit-sharing plans in recent years, particularly in answer to the need of smaller employers for a flexible means of providing deferred compensation, clearly shows the need for legislation opening the way for group annuity profit-sharing plans without the intervention of a trust.

The following amendments are recommended:

1. Section 404 (a) (2)—insert the word "pension" before "plan".

2. Add a new paragraph (4) to section 404 (a) as follows:

"(4) In the taxable year when paid, in an amount determined in accordance with paragraph (3) of this subsection, if the contributions are paid toward the purchase of retirement annuities and such purchase is part of a profit-sharing plan which meets the requirements of section 401 (a) (3), (4), (5) and (6), and if refunds of premiums, if any, are applied within the current taxable year or next succeeding taxable year toward the purchase of such retirement annuities."

3. Reletter present paragraphs (4), (5), (6), and (7) to (5), (6), (7), and (8).

4. In newly designated paragraphs (6) and (7), change the reference to (1), (2), or (3) to (1), (2), (3), or (4).

5. Change first three sentences of newly designated paragraph (8) to read (part to be omitted in brackets; new language in italic):

"[7] (8) LIMIT OF DEDUCTION.-If amounts are deductible (a) under one or more of paragraphs (1) and (2), and also (b) under either or both of paragraphs (3) and (4) in connection with 2 or more trusts, or 1 or more trusts and an annuity plan], the total amount deductible under these paragraphs in a taxable year [under such trusts and plans] shall not exceed 25 percent of the compensation otherwise paid or accrued during the taxable year to the persons who are the beneficiaries under the [of the trusts or] plans. In addition, any amounts contributed [amount paid into such trusts] under such [annuity] plans in any taxable year, in excess of the amount allowable with respect to such year under the preceding sentence [provisions] of this paragraph shall be deductible in the succeeding taxable years in order of time, but the amount so deductible under this sentence in any 1 such succeeding taxable year together with the amount allowable under the first sentence of this paragraph shall not exceed

30 percent of the compensation otherwise paid or accrued during such taxable years to the beneficiaries under the trusts or plans. This paragraph shall not have the effect of reducing the amount otherwise deductible under paragraphs (1), (2), and [(3)] (4), if no employee who is a beneficiary under trusts or plans from which deductions are allowable under section 404 (a) (1) or (2) is also a beneficiary under the trusts or plans for which deductions are allowable under section 404 (a) (3) or (4).”

7. Valuation of life insurance and annuity contracts for estate and gift tax purposes-Sections 2031 and 2512

Treasury Department regulations under both the estate tax and gift tax sections of the Code provide a standardized method for valuing annuities not issued by companies regularly engaged in their sale, and a different method for valuing annuities which are issued by such companies. This double standard creates a serous discrimination against insured annuities, thereby favoring uninsured annuities. The Treasury rules prescribe that uninsured annuities are to be valued on the United States Life Table, 1939-41, with interest at 31⁄2 percent per annum, while insured annuities are to be valued at the price of a comparable contract issued by the company paying the particular annuity.

Our associations had hoped that the enactment of the Code of 1954 and the opportunity it presented for rewriting the regulations and reexamining the errors therein would result in correction of this discrimination. However, when proposed regulations were issued under the new gift tax and estate tax sections the identical discrimination was republished.

It is safe to say that insurance company annuity rates are in all cases higher than corresponding values developed from the United States Life Table, and in most cases a great deal higher. These discrepancies speak for themselves. Most of the difference can be attributed to greatly different assumptions as to future mortality among annuitants, and to different interest assumptions although the contracts create identical liabilities. Part, however, can be attributed to the inclusion of administration and sales expenses in the price of insurance company annuities, items which we believe should be uniformly included or uniformly excluded in valuing both insured and uninsured annuities.

The rule for valuing property generally is that it shall be valued according to the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts. This is a single standard. and should produce a single result-not the double result of the proposed regulation. Given two individuals of the same age and sex and entitled to the same amount of annuity, there seems to be no rationale consistent with this general rule for arriving at different results according to whether the annuity is insured or uninsured. Instead, insured and uninsured annuities should both be valued according to a single standard. It might be that a new plan may be devised to bring other annuities in line with the valuations prescribed for annuities issued by life insurance companies. It seems to be a much preferable course, however, to apply a single set of tables to all annuities because the use of such a table will not only eliminate valuation differences as between insured and uninsured annuities, but as between two or more insured annuities provided by different insurance companies.

We urge that specific legislative provision be made to end this discrimination in valuation which results in the payment of a higher estate tax or gift tax based upon the nature of the issuer and not upon the nature of the benefits actually to be received.

HOUSE WAYS AND MEANS COMMITTEE,
Leo H. Irwin, Clerk,

NEW YORK, N. Y., December 19, 1957.

New House Office Building, Washington, D. C.

DEAR SIR: As the House Ways and Means Committee will open public hearings in Washington on January 7, 1958, concerning general taxation, allow me to make the following statements for the record.

Educating our youth today is not only fashionable or the proper social function but rather a necessity for one's ability to earn a living and, needless to say, for the preparation of being able to perform a service to country.

Again it is needless to say that costs for one's education have risen considerably in recent years, and that the time element for preparation has risen considerably which necessitates additional sums of money.

The burden of financing this program for today's youth falls on the parent who earns a livelihood for the family. It is my suggestion that the head of the family whether filed as a single or joint tax return should be allowed to receive a 100 percent credit or deduction from adjusted gross income for all expenses which are rightfully expended to keep a student in an accredited college. I further suggest that in order to have these records bona fide that each college or university file with the Government a form equivalent to a W-4 for each student showing the exact amounts paid for tuition and relative expenses including board and housing. This principle would be in line with the one now held by the tax department that necessary business exepnses in line with enabling one to perform or earn an income are deductible. The same principle should apply when a parent must spend large sums of money in order to train and prepare a child to have the means with which to earn a living later in life and to be of service to man and country.

I trust your honorable committee will consider this proposal and if it is necessary for a personal appearance at any of the committee meetings I should arrange for same upon due notice. With kind thanks in advance and with greetings for the holiday season.

Very truly yours,

MURRAY M. MAGLOFF.

STATEMENT OF TEACHERS INSURANCE AND ANNUITY ASSOCIATION OF AMERICA

Teachers Insurance and Annuity Association of America appreciates this opportunity to file a statement with this committee for the record of its hearings on general tax revision. In this statement we wish to call attention to the problems of retirement plans of nonprofit educational organizations arising under certain provisions of the Internal Revenue Code of 1954. These provisions include sections 101 (b) (2) (B), 403 (a) (2), and 2039 (c). In addition, the proposed section 57 of H. R. 8381, paralleling section 2039 (c), gives rise to the same questions.

Our particular interest in this matter is in behalf of participants and beneficiaries under the 774 retirement plans of United States educational organizations (as of the end of 1957) which are funded and administered through contracts issued by us.

Before the Internal Revenue Code of 1954 was enacted, participants and beneficiaries under the retirement plans of tax-exempt educational organizations were given the same tax treatment as participants and beneficiaries under the qualified retirement plans of taxable commercial organizations. This resulted from the provision in section 22 (b) (2) (B) of the Internal Revenue Code of 1939, which dealt with the status of employer contributions to retirement plans as they affect individual income tax liability. This provision was continued in substance in section 403 (a) (1) of the Internal Revenue Code of 1954, and to that extent consistent treatment under the retirement plans of tax-exempt educational organizations has been continued.

Certain new provisions of the Internal Revenue Code of 1954, however, which provide additional tax benefits for participants and beneficiaries under retirement plans are available only in the case of qualified plans. To that extent the Internal Revenue Code has departed from the former consistent treatment of the two categories of retirement plans. These tax-relief provisions, referred to in the first paragraph above, were discussed by us in more detail in our appearance before the Mills subcommittee on November 20, 1956 (record of hearings, at pp. 123, 151).

Our appearance before the subcommittee at that time was in connection with the concern of the Treasury and the subcommittee over certain problems which have arisen under that part of section 403 (a) (1) which covers the retirement plans of tax-exempt educational organizations. It was the conclusion of this committee, in the proposed new section 403 (b) embodied in section 19 of H. R. 8381, that corrective legislation was needed. If legislation is deemed necessary, we feel that the formula set forth in the proposed section 403 (b) is a fair one, which allows reasonable latitude for the development of sound retirement plans, while at the same time preventing any substantial abuse of the tax benefit.

In reporting H. R. 8381, however, this committee did not deal with the further problems mentioned by us in our appearance before the subcommittee, which are the subject of this statement. It should be completely feasible to extend the treatment now provided in section 403 (a) (1) consistently to the other aspects of the tax position of participants and beneficiaries. This is especially