11. The previously-taxed-property provision should apply to a transfer by death followed by the death of the recipient, under either a dual tax system or a unified tax, but should apply to a lifetime transfer followed by the death of the recipient only under a unified tax.

12. The previously-taxed-property benefit to the recipient should be available on a 100% basis for the first six years and should diminish by 20% each year thereafter and terminate completely after ten years, under either a dual tax system or a unified tax.

H. The Generation-Skipping Problem11

No present Internal Revenue Code provision

A transfer tax system should not only provide relief against the imposition of the tax too frequently (the previously-taxedproperty problem) but should also prevent too infrequent impositions of the tax. This problem of the too-infrequent impositions of tax has the same scope under a dual tax system or a unified tax.

The problem arises because the movement of beneficial enjoyment through successive owners of beneficial interests for life is not regarded as a transfer for transfer tax purposes unless each successive beneficial life owner is given a power that is deemed the equivalent of outright ownership for transfer tax purposes. Thus, under present law, there may be no imposition of the transfer tax for the period of the controlling rule against perpetuities plus the life of the person in whom outright owner-. ship ultimately rests. This conceivably may exceed one hundred years or even substantially longer.

The generation-skipping transfer, if it does not incur a transfer tax somewhat (though not precisely) comparable to the transfer taxes imposed when the property moves outright from generation to generation, is an undermining influence in the operation of a transfer tax system. If the total transfer tax burden on an outright transfer from A to his son S and a subsequent transfer by S to his child is significantly larger than on a transfer from A to S for life and then to his child, the tax structure is underwriting and encouraging the generationskipping transfer.

"For fuller discussion, see Reporter's Study, at pp. 166-178 infra.

1. Transfers to be Subject to Additional Tax

There is considerable sentiment that something should be done about the problem but no unanimity as to what should be done. The range of suggested solutions goes from the strict position that an additional tax should be imposed on any transfer that would skip a generation, through the view that would not impose an additional tax on a transfer that skipped only the first generation, to the view that would write in a federal rule against perpetuities of slightly less scope than the generally prevailing common law rule in fixing the period that generations might be skipped without the imposition of an additional tax on the transfer."

At the May 1967 meeting of the Tax Advisory Group, the Reporter asked how many would favor imposing an additional tax on any transfer that might skip the first generation down, except where the transfer was to the second generation down and the parent of that generation was deceased at the time of the transfer, if the choice were between that solution and doing nothing. Eighteen (18) favored that solution while twentynine (29) would prefer to do nothing.

Next the Reporter asked how many would accept the solution described in the preceding paragraph modified to permit outright gifts or their equivalent to anyone, rather than do nothing. The vote on this question was, twenty-three (23) to accept the solution as thus modified rather than do nothing, and twenty-two (22) to do nothing.

The votes referred to in the two preceding paragraphs should not be taken as indicating that the number who voted for the first solution or for the alternative were in favor of it over all other alternatives. Some might have concluded that a more lenient alternative was preferable, but regarded the problem as sufficiently serious to justify accepting the solution rather than do nothing.

At the June 1967 meeting of the Consultants, an attempt was made to ascertain their position as to where to draw the line in regard to generation-skipping transfers. With nine consultants voting, one preferred over all other alternatives the solution that would impose the additional tax on all transfers

that skip a generation without the exception that allows the generation-skipping transfer if the transferee's parent is deceased; one favored such solution with such exception; and three favored such solution with all outright transfers to any person excepted. Four consultants favored one or another more lenient alternative.

The Council of the Institute considered the generationskipping problem on two different occasions. In the original consideration, the vote was 21 to 1 that something should be done to prevent the avoidance of transfer taxation by transfers of successive limited interests lasting several generations. On the second consideration of the matter, the vote in favor of doing something was 17 to 8. On both occasions the Council rejected by a one-vote margin the solution that would impose the additional tax on all transfers that skipped one generation except outright transfers. This solution was presented to the Institute membership and was decisively rejected.13

13

The Council, by a vote of 23 to 3, did support a solution that would impose the additional tax on a transfer of a limited interest but only if such limited interest postponed the outright ownership of the transferred property, or its equivalent, beyond the death of a person one generation below the transferor. A transfer by A to his son for life, then to the son's issue living at the son's death, would not be subject to the additional tax under this solution. A transfer by A to his son for life, then to his son's oldest child for life, then to the son's issue living on the death of the survivor of the son and his oldest child, would be subject to the additional tax under this solution. Outright ownership, or its equivalent, is not postponed merely because

"The resolution presented to the Institute read as follows:

Resolved, that the additional transfer tax be applicable to the transfer of a limited interest if distribution of benefits may be made under the transfer to a person more than one generation below the transferor, such additional tax to be imposed at the average rate applicable to all transfers by the transferor in the taxable period of the transfer, and such additional tax to be imposed at the time of the transfer or at the time of distribution to a person more than one generation below the transferor, as the transferor or his personal representative may elect, and that such additional tax be collectible only out of the property on which the additional tax is imposed, unless the transferor specifies other funds out of which the additional tax is to be paid.

distribution may be delayed in carrying through the various administrative tasks of terminating a trust.

2. Time of Payment of Additional Tax

In dealing with a transfer that creates successive limited interests, an additional tax could be imposed at the time the transfer is initially made, or at the time of the shift of enjoyment or an election could be given at the time the original transfer is made whether to pay then or defer the tax. At the May 1967 meeting of the Tax Advisory Group, it was voted 35 to 15 to permit the additional tax to be deferred until beneficial enjoyment passes beyond the first generation, and 30 to 13 to give an election to pay up the additional tax initially or defer it.

3. Rate of Additional Tax

The amount of the additional tax, if paid initially, has to be fixed on some basis. Too many variables are involved to calculate the additional tax that is to be paid on the basis of how much would be collected in transfer taxes if the particular property passed outright to the successive takers whose limited interests invoke the additional tax. Thus, a somewhat arbitrary rate is suggested which is the average rate applicable to the transfers of the transferor in the period the initial transfer is made. This average rate would be applied to the value of the property in a transfer subject to the additional tax at the time of the transfer, if the additional tax is to be fully paid up at the beginning. This additional tax would be imposed only on the value of such property that is left after taking out any normal tax payable out of it, and the aggregate of the normal and additional taxes should be subject to some reasonable ceiling. The additional tax would be collectible only out of the property subject to it if it is paid initially, unless the transferor directs otherwise.14

"This rule for determining the rate of additional tax on lifetime transfers will make the ultimate burden of additional tax lighter for a taxpayer who makes generation-skipping transfers at the beginning of his donative career than if he made the same generation-skipping transfers later on. This feature could be avoided if the additional tax on lifetime transfers were computed by way of an imputed additional gift that would be taken into account in taxing subsequent

If the additional tax imposed on the transfer is deferred and paid at the time there is an actual distribution to a person more than one generation below the transferor, the rate of the tax could conceivably be the same rate that would apply if the parent of the recipient had made the transfer, so that the taxes would ultimately be the same as if the excessive postponement of the distribution had not occurred. In the early stages of this project, considerable effort went into such an approach, but it was finally rejected because of the complications that developed in dealing with all the ramifications of the problem. The work done on this approach is preserved in Appendix B to the Reporter's Study, pp. 351-410. It is now proposed that the rate of tax on a distribution that would be subject to the additional tax, if the payment is deferred until distribution, should be the same as the rate that would be imposed if the additional tax were paid on the initial transfer. Even though the rate would be the same, it may be desirable to pay initially because if the tax is deferred the amount subject to additional tax will include appreciation in value and income accumulated during the period of deferral.

Adoption of an additional tax on generation-skipping transfers would not eliminate such transfers because there will be many situations where it would still be desirable to employ such a transfer even though an additional tax is payable. The increase in revenue from this proposal is considered in Appendix C, at page 410.

With respect to the generation-skipping problem the Institute adopted resolutions recommending that:

13. Under either a dual tax system or a unified tax, an additional tax should be imposed to deal with the problem of the avoidance of transfer taxes by a succession of limited beneficial interests that may continue through several generations.15

14. Under either a dual tax system or a unified tax, an additional tax should not be imposed on an outright transfer, or its equivalent.

"There was a substantial division within the Institute on this resolution which was adopted by about a three-to-two vote.