22. Timely redirection of the destination of a property interest should be regarded as a disclaimer for the purpose of determining the transfer tax consequences of the original transfer, under either a dual tax system or a unified tax.

L. The Completed vs. Uncompleted Gift Problem21

Internal Revenue Code Secs. 2012, 2035, 2036, 2037 and 2038

Under present law, a lifetime arrangement with respect to property may or may not be a completed gift for gift tax purposes. Moreover, even though the arrangement involves a completed gift for gift tax purposes, it may not remove the value of the property from the donor's gross estate for estate tax purposes. This treatment of such completed lifetime gifts—in other words, the area of double transfer taxation-has been thought to be necessary to prevent lifetime transfers that have some of the characteristics of a deathtime transfer from escaping the higher estate tax rate schedule. The gift tax paid on these transfers that are also subject to estate taxation will give rise to a credit against the estate tax assessed on the same transfer (I.R.C. Sec. 2012).

It is proposed, under either a dual tax system or a unified tax, to eliminate this double taxation area by treating every arrangement as involving either a lifetime transfer or a deathtime transfer, but never both. Such elimination will simplify the transfer tax structure.

Under a unified tax, the ultimate tax liability is designed to be approximately the same whether a transfer occurs during life or at death. Hence, the line between lifetime and deathtime transfers can be drawn wherever is most convenient. Under a dual tax system, on the other hand, it becomes important not to treat as a lifetime transfer any arrangement with significant testamentary features, because the tax burden on lifetime transfers will generally not be an adequate substitute for death taxes.

1. Retained or Granted Powers

Often a transferor retains (or confers on a trustee or another) power to determine later the ultimate disposition of

21

For fuller discussion, see Reporter's Study, at pp. 188-198 infra.

property transferred by him. In such cases, it is proposed that under a unified tax the existence of a power in a lifetime arrangement should not prevent a transfer from being completed for transfer tax purposes unless (1) the power can be exercised in favor of the transferor, and (2) the power is exercisable by him alone or in conjunction with one who does not have a substantial interest that would be adversely affected by the exercise of the power.

The acceptance of this policy in the power cases under the unified tax would result in a completed gift in many cases that would be subject to estate taxes today. It would allow a transferor to retain many strings on a transfer and nevertheless get the value of the future growth out from under transfer taxation, as long as the strings do not permit the transferor to pull the property back to himself. This easy-to-complete-gift policy that is possible under a unified tax is regarded by some as one of the most attractive features of such a tax. The vote of the Tax Advisory Group at the May 1967 meeting was 43 to 2 in favor of an easy-to-complete-gift rule if a unified tax is enacted.

22

The easy-to-complete-gift rule in the power cases would not be compatible with the dual tax system. If a donor is to get the advantages of taking property off the top bracket of the estate tax rate schedule, he should be required to sever his relationship with the property rather definitively. A number of alternatives as to where the completed lifetime gift line might be drawn in the power cases, each making it more difficult to complete the gift, are easy to formulate. At the May 1967 meeting of the Tax Advisory Group, 43 (as against 7 who favored some other line) voted for a hard-to-complete-gift rule under a dual tax system which had the following characteristics: A lifetime arrangement would not involve a completed gift if there is a power in anyone to modify who takes or to modify when a beneficiary takes, except that an otherwise completed gift would not be rendered incomplete if the power is in someone other than the transferor and (a) is exercisable only by will, or (b) the existence of the power causes such person to be treated as the owner of the transferred property for transfer tax purposes, or (c) the power is one that would not cause the income to be taxable to the transferor under Sec. -For fuller discussion, see Reporter's Study, at pp. 188-198 infra.

674(c) of the Code. In the last instance this means the power must not rest at all in the transferor and not more than half of the powerholders can be in the related or subordinate category as defined by Sec. 672.

Though a lifetime arrangement may be a completed gift under the power tests, it may be an incomplete one for one or another of the reasons noted below. The proposed line between completed and uncompleted gifts in other than the power cases should be the same under the dual tax system and unified tax except in the case of gifts in contemplation of death.

2. Retained Current Beneficial Enjoyment

It is proposed that a lifetime arrangement under which the transferor retains the current beneficial enjoyment of the transferred property be regarded as an incomplete gift even though the interests of others in the transferred property on the termination of the current beneficial enjoyment are irrevocably fixed. This is a change from present law, under which an irrevocable transfer of property with income retained by the transferor involves a completed gift of the remainder interest for gift tax purposes. The transferred property is also included in the transferor's gross estate for estate tax purposes (I.R.C. Sec. 2036), with a credit for some or all of the gift tax paid (I.R.C. Sec. 2012). In eliminating the double tax area, this transfer has been placed on the uncompleted gift side of the line with the result that it would be taxed as a transfer only at the time the current beneficial enjoyment ends. This would make these arrangements possible without the transferor diminishing his holdings by the payment of a transfer tax at the time the arrangement is established. The proposal to put this arrangement on the uncompleted gift side would apply under either a dual tax system or a unified tax.

3. Retained Reversionary Interest That is
Certain to Become Possessory

It is proposed that if the transferor retains a reversionary interest that is certain to become possessory he be treated as making a completed gift of only the interests that precede his

ary interest would be treated as transferred only upon the termination or transfer of the reversionary interest. The retained reversionary interest that is certain to become possessory is close to the retained-current-beneficial-enjoyment case insofar as interests that follow the retained interest are concerned and the two should be treated similarly. This type of lifetime arrangement should be treated the same under either a dual tax system or a unified tax.

4. Employee Death Benefits

It is proposed that any inter vivos arrangement as to the payment of employee death benefits would be on the uncompleted gift side of the line. Such an arrangement is like a transfer with current benefits retained by the employee and should be treated accordingly. The employee death benefit rule would apply to any life insurance feature that was a part of an employee benefit plan. The same position is proposed under either a dual tax system or a unified tax.

5. Life Insurance

Life insurance proceeds are subject to death taxation if the insured retains any incident of ownership. Hence no transfer of a policy should be treated as a completed gift when a taxsignificant incident of ownership is retained by the insured, if the double tax area is to be eliminated. If a transferee of some, but less than all, of the tax-significant incidents of ownership exercises an incident given to him to withdraw for his exclusive benefit some of the intrinsic value of the policy, a completed gift of such value should occur at that time because the transferor's incidents of ownership will be destroyed with respect to the amount withdrawn. This position as to life insurance is suggested under either a dual tax system or a unified tax.

6. Gifts Shortly Before Death

A transfer within some limited period of time prior to death raises the problem of a gift in contemplation of death. Under present law, the gift is presumed to be in contemplation

of death if made within a period of three years before the death of the transferor. If the presumption is not overcome, the value of the transferred property is subject to estate tax (I.R.C. Sec. 2035), with a credit against such tax for all or part of the gift tax paid (I.R.C. Sec. 2012). The gift in contemplation of death normally reduces the transfer tax below what it would have been if the gift had not been made, because the amount paid in gift taxes, which becomes a credit against the estate tax, is not itself subject to estate taxation. In other words, no gift or estate tax is assessed on the money used to pay the gift tax, but there is a tax imposed on the portion of the decedent's estate used to pay the estate tax, except in the case where a portion of the estate tax is paid by the credit available for the gift tax paid.

In drawing a line that prevents double taxation in the field of gifts shortly before death, it is proposed under the dual tax system to retain the present three-year presumption as to gifts in contemplation of death. However, it is proposed that if the presumption is not overcome, the value of the gift should be subject to estate taxation, and the estate should be entitled to a refund of any gift tax paid. Since the refund would be included as an asset in the gross estate, the end result would be only one tax, as though the lifetime transfer had not been made at all.

Under a unified tax, the gift made shortly before death produces no significant advantage because its value moves up the beginning bracket applicable to deathtime transfers, except to the extent the amount paid in transfer taxes on the lifetime transfer is excluded from taxation. It is proposed that the amount paid in transfer taxes on a lifetime transfer in either of the two taxable periods prior to the transferor's death be treated as a deathtime transfer and taxed accordingly. This result would follow without regard to the contemplation-ofdeath issue and would eliminate the contemplation-of-death problem of present law.

With respect to the completed and uncompleted gift problem the Institute adopted resolutions recommending that:

23. A line between completed and uncompleted gifts should be definitively established, so that all lifetime arrangements would fall on one side of the line or the other,