Private Inurement and Private Benefit

In 1991, the Committee held a hearing on the tax-exempt status of hospitals and other health care organizations. Among other things, the Committee_reviewed the rules relating to private inurement, private benefit and the provision of charity care. At the hearing, both the Treasury Department and the Internal Revenue Service emphasized the difficulty of enforcing the private inurement and private benefit rules because, under current law, the only available sanction is revocation of tax-exempt status.

Following the hearing, no further legislative activity was undertaken.

In 1992, the Committee included a provision in H.R. 2735 to extend the private inurement restriction to social welfare organizations (e.g., health maintenance organizations exempt under section 501(c)(4). This provision was incorporated in H.R. 11, which was vetoed by the President on November 5, 1992.

TABLE 4.-TAX-EXEMPT ORGANIZATIONS, RECENT HISTORY

Excluding taxable farmers' cooperatives and nonexempt charitable trusts. 2 Includes forms 990, 990T, 990C, 5227, and 4720.

Source: Internal Revenue Service. Annual reports. Various years.

TABLE 5. SELECTED DATA FOR NONPROFIT CHARITABLE ORGANIZATIONS, REPORTING

Notes: Detail may not add to totals because of rounding. Nonprofit organizations exclude private foundations and religious organizations.

Source: Internal Revenue Service. SOI Bulletin. Vol. 12, No.1. (Summer, 1992).

TABLE 6. NUMBER OF RETURNS AND AMOUNTS OF UNRELATED BUSINESS

1The IRS conducted a Taxpayer Compliance Measurement Program (TCMP) on Forms 990-T filed in fiscal year 1987.

Source: Internal Revenue Service.

Section 3. Estate and Gift Taxes

A. OVERVIEW

Estate and gift taxes are transfer taxes imposed upon the privilege of transferring property. As such, they are to be distinguished from inheritance taxes, which most States impose upon the privilege of receiving property from deceased persons. The Federal tax system does not include inheritance taxes.

Several justifications, apart from the generation of revenues, have been offered for the imposition of estate and gift taxes. Historically, they have been viewed, in Franklin D. Roosevelt's words, as an appropriate means of preventing "the perpetuation of great and undesirable concentrations of control in a relatively few individuals over the employment and welfare of many, many others." They have also been justified as an appropriate means of recompensing the Government for the protection of property rights. It has also been argued that estate and gift taxes play an important role in backstopping the Federal income tax system, which currently does not include in its base wealth accumulated during an individual's lifetime. That is, because of the "step up" in basis, capital gains on assets held at death are exempt from the income tax. Such assets, however, may be subject to the estate tax if held in a sufficiently large estate. From this perspective, estate and gift taxes contribute to the progressivity of the Federal tax system. Some observers challenge this view and contend that the nontaxation of capital gains on assets held at death is not a feature of the income tax that requires "correction."

The estate and gift taxes have been criticized as reducing incentives for economic growth and saving, even though it is generally acknowledged that estate and gift taxes have less of an impact on these incentives than do income taxes that raise equivalent amounts of revenue. Estate and gift taxes have also been criticized as being burdensome to families that are only beginning to prosper. These concerns are mitigated, however, by the relatively large exemptions provided from estate and gift taxes.

Estate and gift taxes provide only a relatively minor portion of total Federal revenues. For instance, in 1992, estate and gift taxes accounted for only about $11.1 billion out of total Federal receipts of $1,092 billion. (See table 1, Part IV, "Historical Tables".)

Estate tax

B. HISTORICAL BACKGROUND

The first estate tax was enacted in 1916 to help finance United States efforts in the First World War. The estate tax has been in place continuously since then.

Initially, the estate tax rates ranged from 1 to 10 percent, with a $50,000 exemption. Table 1 shows how the rates and exemption amounts have fluctuated historically up until the present. As that table shows, rates reached a maximum of 77 percent during the Second World War and declined to a maximum rate of 55 percent in 1992. The maximum rate declined again to 50 percent in 1993.1 Gift tax

The first gift tax was enacted in 1924 to prevent wealthy individuals from avoiding the relatively new estate tax by disposing of their property before death. After 2 years, the gift tax was repealed and replaced by a provision that treated all gifts made within 2 years of death as being part of the decedent's estate. Constitutional objections arose to this provision, and the gift tax was reinstituted in 1932.

As table 2 shows, gift tax rates from 1932 until 1976 were 75 percent of the estate tax rates. The 1932 law allowed a lifetime gift-tax exemption of $50,000, which was reduced to $40,000 in 1935 and to $30,000 in 1942. This separate lifetime gift-tax exemption was repealed in 1977, when the estate and gift tax systems were unified.

The 1932 law also allowed taxpayers to make annual gifts taxfree, in an amount not to exceed $5,000 for each donee. This annual per donee exclusion was reduced to $4,000 in 1938 and $3,000 in 1942, and was increased to $10,000 in 1982.

Unification of gift and estate tax systems

The Tax Reform Act of 1976 ("1976 Act") introduced a major structural change by unifying the estate tax and gift tax systems, so that a single progressive rate schedule applied to the aggregate transfers made at death and by gift during life.

The 1976 Act also replaced the separate estate and gift tax exemptions with a single unified tax credit. This credit was originally set at $30,000, which equated to an exemption amount of $120,667. This credit has been increased until reaching in 1987 its current level of $192,800, which equates to an exemption of $600,000.

The 1976 Act also liberalized the treatment of property transfers between spouses. To equalize the treatment of community property States and noncommunity property States, the law since 1948 had allowed marital deductions for estate and gift tax purposes for onehalf the value of noncommunity property passing to a spouse (i.e., noncommunity property was given the same treatment that automatically accrues to community property, which by law belongs equally to each spouse). The 1948 law also permitted husbands and wives to split gifts to third parties between themselves, which effectively doubled exemption amounts available and allowed for potentially lower graduated rates.

The 1976 Act increased the marital deduction for estate tax purposes to the higher of one-half the estate or $250,000. For gift tax purposes, the marital deduction was 100 percent for the first $100,000, and one-half the amount over $200,000. The Economic

1The maximum rates of 53 and 55 percent assessed on large estates were extended in the "Revenue Act of 1992" (H.R. 11), to remain in effect until after 1997. This bill passed both the House and the Senate in October 1992, but was vetoed by President Bush.

Recovery Tax Act of 1981 simplified and further liberalized these rules by allowing an unlimited marital deduction for estate and gift tax purposes. These laws retained the provisions for gift splitting between spouses. The 1976 legislation also provided relief for family farms and small businesses by providing favorable valuation rules (Code section 2032A) and by providing a 14-year extension for payment of estate tax where the estate consists largely of interests in a closely held business (Code section 6166). The 1976 Act also introduced the generation-skipping tax, which originally applied only to transfers of trust property benefiting more than one generation. The purpose was to prevent avoidance of transfer taxes through use of trusts. In the 1986 Act, the generation-skipping tax was made more comprehensive by extending it to cover outright transfers that skip generations. The generation-skipping tax is computed by reference to the maximum Federal estate tax rate.

C. CURRENT STRUCTURE OF ESTATE AND GIFT TAX SYSTEM

The estate tax

The estate tax is levied on the gross estate less various deductions. The gross estate includes the value of all property in which the decedent had an ownership interest at death. Generally, the value of the decedent's property interest is its fair market value at death, although the executor may elect to use an alternate valuation date, generally 6 months after death. Real property used in farming or other closely held businesses may be eligible for reduced valuation.

The following deductions are allowable from the gross estate to determine the taxable estate: (1) administration and funeral expenses; (2) claims against the estate and obligations; (3) casualty and theft losses; (4) the marital deduction for most property passing between spouses; and (5) the charitable deduction.

A single unified rate schedule applies for both estate and gift taxes. The rates begin at 18 percent on the first $10,000 of taxable transfers and increase to 55 percent for transfers over $3,000,000. The graduated rates and unified credit are gradually phased out for transfers over $10,000,000, until being completely phased out at $21,040,000.

The gross estate tax is computed by first figuring a tentative tax on the sum of the taxable estate and the amount of adjusted taxable gifts that were made by the decedent after 1976 and that are not includable in the gross estate. One then subtracts from this tentative tax the total amount of tax payable for gifts made after 1976.

Various credits are subtracted from the gross estate tax to yield the net estate tax payable. The most important of these credits are the unified credit and the credit for State death taxes. The unified credit of $192,800 effectively exempts from taxation estates valued at $600,000 or less.

The gift tax

The gift tax is imposed on all transfers of property or property interests that are made without adequate consideration, excepting certain tuition and medical expense payments and transfers to