15. Under either a dual tax system or a unified tax, the additional tax should be applicable to the transfer of a limited interest if, but only if, distribution of benefits may be made under the transfer to a person more than one generation below the transferor at a time subsequent to the death of a person one generation below the transferor.16

Such additional tax should be: (a) imposed at the average rate applicable to all transfers by the transferor in the taxable period of the transfer, (b) 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 (c) 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.

I. The Interspousal Transfer Problem17

Internal Revenue Code Secs. 2056 and 2523

The marital deduction has now been with us since 1948. It was originally adopted in an effort to bring about greater equality in the operation of the gift and estate tax laws in community property states and non-community property states. In view of the fact that community property is divided between husband and wife on a 50-50 basis, the marital deduction was limited to about 50% of the donor spouse's estate. More precisely, the gift tax marital deduction is 50% of each gift from one spouse to the other, and the maximum estate tax marital deduction is 50% of the deceased spouse's adjusted gross estate. We will refer to the present rules as "the 50% marital deduction."

The interest of each spouse in community property is ordinarily the equivalent of outright ownership, subject to the managerial control of the community property that may be vested in one of the spouses. In particular, a spouse's interest in community property does not ordinarily terminate on death.

The Institute considered this resolution on the understanding that it meant that no additional tax would be imposed on a transfer under which final distribution is required to be made no later than the death of a person or persons one generation below the transferor, or in the same generation or in a higher generation than the transferor.

Thus, the so-called terminable-interest rule was developed under which transfer to a spouse of certain terminable interests do not qualify for the 50% marital deduction. In other words, generally speaking, the donee spouse must receive an interest somewhat equivalent to outright ownership, for the gift to her to qualify for the marital deduction. The technical requirements to qualify an interest other than outright ownership for the marital deduction are fairly complex, and some of the courts have taken a highly technical approach to these requirements, with the result that many good faith efforts to meet the legal requirements have failed.

In community property states, the marital deduction is not available unless one or the other of the spouses owns some separate property. Under certain circumstances, moreover, separate property of one spouse that reached that character as a result of the conversion of community property to separate property is tainted for marital deduction purposes and must still be regarded as community property in working out the marital deduction. In effect, the maximum marital deduction available in a community property state for deathtime transfers is approximately one half of the value of the non-tainted separate property, but transfers on death of community property can be utilized to make up such allowable marital deduction.

1. 100% Marital Deduction

Dissatisfaction with the 50% limit on the marital deduction stems from these concerns: First, it does not achieve complete equality of tax treatment as between community and noncommunity property states because the marital deduction for lifetime transfers is limited to 50% of the value of each gift to the donee spouse; Second, it still results in the imposition of a transfer tax on the movement of property from spouse to spouse and forces them into an unnatural record-keeping of interspousal transfers if the law is to be complied with; Third, frequently the tax that has to be paid as a result of an interspousal

"Under community property laws half a husband's accumulated earnings, for example, will become his wife's without any taxable transfer, and will thus be removed from his taxable estate even if the wife is the first to die. In a common law state the husband would be left with all the accumulated earnings taxable in his estate, if he survives, unless he had made gifts to his wife before her death.

transfer comes at the death of a spouse, a time when significant sources of income may disappear, and hence not a time when a further economic adjustment should be required to pay taxes on the transfer; Fourth, very complex dispositions are necessary to give the surviving spouse on the donor spouse's death the exact 50% that is the maximum marital deduction; and Fifth, in smaller estates, the 50% marital deduction is frequently inadequate to provide the surviving spouse with an adequate taxfree amount.

A 100% marital deduction with no disqualification of community property would eliminate all the concerns mentioned in regard to the 50% marital deduction and bring to full fruition from a tax standpoint the often expressed attitude of husband and wife that the property is "ours" without regard to the technical legal ownership requirements.

2. Current Beneficial Enjoyment Test

It is proposed that any transfer (whether the property transferred is community property or separate property) which provides the donee spouse with the current beneficial enjoyment of the property should qualify for the marital deduction to the extent of the full value of the property. In the case of income-producing property, current beneficial enjoyment means the right to receive the income. Thus, a transfer to T in trust with directions to pay the income to the donor's wife for life, with remainder over to designated beneficiaries and with no power in the wife to change the destination of the property on her death would qualify for the marital deduction under the current-beneficial-enjoyment test. This type of trust can be used where the donor spouse wants to protect his children from being left out as a result, for example, of the second marriage of his spouse.

The introduction of the current-beneficial-enjoyment test and the accompanying elimination of the terminable-interest rule might be said to give the common law states some advantage over the community property states, in that in the latter the surviving spouse will end up owning outright, with full control, one half of the community property, whereas in a common law state the same tax benefit can be produced by giving the

community property state the deceased spouse's half of the community property could also be qualified for the marital deduction by giving the surviving spouse only a life interest therein. Moreover, it would be possible in a community property state, if one spouse can transfer his share of the community property to the other, for a spouse to transfer his share of the community property to the other spouse without any transfer tax cost and then the receiving spouse could deal with the entire property in the same way as in a common law state.

If terminable interests qualify for the marital deduction, then a transfer would be considered to be made by the donee spouse whenever the current beneficial enjoyment ceases. This will be on her death, if she is given a life interest, but may be prior to her death if she is given a current interest until she remarries or for some stated period of time. The property she is treated as transferring on the termination of her current beneficial enjoyment may pass to predetermined beneficiaries. It would not be fair to her to subject her other assets to the payment of the tax assessed on this imputed transfer. Furthermore, the tax on this transfer should be at the top rate for the taxable period involved, so that the tax on other assets transferred by her in such period is not higher than it otherwise would be. So far as deathtime transfers are concerned, this will mean the imputed transfers will always be taxed at the donee spouse's ultimate top rate. So far as lifetime transfers are concerned, however, an imputed transfer in one taxable period, though at the top rate for that period, would affect the beginning rate applicable to transfers in a future period, unless some special rule is adopted to cover this situation. In the usual case, the imputed transfer will not occur prior to death. In the instances where it does, one possibility would be to tax the imputed transfer at what would be the top rate if all the property then owned by the wife were transferred, and to ignore the value of the imputed transfer in determining the rate at which other transfers are taxed.

3. Election as to Time of Imposition of Tax

Under the present marital deduction, there is no election. available to pay the tax on a qualified marital deduction gift at

the time of the transfer and eliminate from transfer taxation the movement of the beneficial enjoyment out of the donee spouse. Somewhat the same end may be accomplished by giving the donee spouse a benefit that does not qualify for the marital deduction and under which she will not be regarded as the owner for transfer tax purposes. If a change is made to a current-beneficial-enjoyment test, the area of qualified marital deduction gifts will expand tremendously. An election should therefore be given to treat a qualified marital deduction gift as subject to the transfer tax at the time it is made, with provision that no transfer tax would then be imposed on the termination of the donee spouse's current beneficial enjoyment. This would mean that if the entire current benefit were conferred on the donee spouse in the form of a life interest, one half could be taxed at the donor spouse's death and the other half at the donee spouse's death (or any other fractional division), if that appeared desirable in the particular case. Also, the donee spouse could be given the outright ownership of property and an election made to pay a tax thereon (or on some part) at the time of the donor spouse's transfer and, if the property on which the tax had been paid could be traced, no tax would be payable on its transfer by the don e spouse.

4. Applicability to Dual and Unified Tax

The 100% marital deduction for deathtime transfers is almost essential where a unified tax is involved. Otherwise, if only a 50% marital deduction were available, the beginning deathtime transfer tax rate might be built up by lifetime transfers to persons other than the donor's spouse to the point where adequate provisions could not be made for the spouse on death out of what would be left after the tax bite. This danger does not exist to the same degree under a dual tax system because no matter how extensive the lifetime transfers are, a fresh start at the bottom of the estate tax schedule would be available to the 50% that could not qualify under a 50% limitation on the maximum marital deduction.

A 100% marital deduction makes it possible in moving