There remains the issue of what form a change in the basis rule should take. Clearly, an important consideration should be simplicity of operation. To the extent possible, a new rule should not complicate the administration of estates. On this point, we find both the carryover basis proposal and the capital gains tax proposal of the Treasury Studies seriously defective. It is indisputable that the simplest system would be one that continues current law to the extent of giving assets included in a decedent's gross estate a basis equal to their estate tax value because no new rules would have to be developed regarding the administration of decedent's estates. Carryover does not do so. Neither does the Treasury Studies capital gains tax proposal because of its exemption from the new tax of property qualifying for the marital or charitable deduction and its complex reallocation of basis procedure. The Studies' hybrid approach, when one of these deductions is present, of part capital gains tax and part carryover combines the worst elements of both proposals. Another important consideration is fairness. Here again we find the capital gains tax proposal, and to a lesser extent carryover, defective. The inpact of the capital gains tax proposal when taken in conjunction with the estate tax is uneven and favors the large estate. Put another way, the tax is regressive. This is caused by the removal, through an estate tax deduction for the capital gains tax, from the estate tax base of a portion of the estate assets which would otherwise be taxed at the highest estate tax rate or rates. Thus, the true rate of tax on the gain is a function of the complement of the highest estate tax rate or rates at which the deducted capital gains tax would otherwise be taxed in the estate (1.e., the complement of x is 100-x). To 11lustrate using current rates, an estate taxed at the highest rate of 77% would be subject to an effective net additional tax commencing at only 23% of the actual capital gains tax paid but an estate whose highest estate tax rate was 30% would be subject to an effective net additional tax of at least 70% of the actual capital gains tax paid. Lower estate tax rates alone cannot remedy the inequitable and unfair impact of the capital gains tax proposal on the medium estate. In place of a single variable--size--presently employed to determine the estate tax, fairness requires that two variables--size and percentage (or amount) of gain--be considered. A reduction in estate tax rates deals with only one of these variables- size. The regressive nature of the capital gains tax proposal may be demonstrated by an illustration using the lower transfer tax rate schedule of the Treasury Studies and the 25% capital gains tax rate in effect when the Studies were published. This may be illustrated by, comparing two estates, one with a $4,500,000 gross estate and an aggregate basis of $1,500,000 and the other with a $450,000 gross estate and an aggregate basis of $150,000. When compared with the estate tax payable under current law, the increase in tax would be 28% for the smaller estate and less than 1% for the larger estate. The percentage difference becomes almost 37% if current capital gains rates are used and income averaging is ignored. Moving to the carryover basis proposal, when a marital deduction or community property is present the basis of all estate property including that qualifying for the marital deduction or the surviving spouse's share of the community would be increased by the estate tax attributable to net appreciation. result is unfair because property qualifying for the marital deduction or the surviving spouse's share of the community does not generate any estate tax. The This entire basis increase should be allocated to the non-marital property and none to the surviving spouse's share of community property. The effect of not making such an allocation will often be to increase the capital gains taxes incurred to raise funds with which to pay estate taxes because the basis increase in the non-marital property will be lower than it would be if the entire increase were allocated to such property. In a separate property estate involving the marital deduction, a solution is difficult because it will not be known at a decedent's death what property passes to the marital and non-marital funds and, therefore, the property entitled to the basis increase is uncertain at the very time sales will be made As a result, the Internal Revenue Service would become an active participant in the distribution of estates. for taxes. In a community property estate, the basis adjustment can easily be allocated entirely to the decedent's half of community assets but in so doing the surviving spouse may be penalized. Sales to raise funds for taxes and expenses may include both halves of community assets and the surviving spouse is involuntarily burdened with reporting gain realized as to her community half of each community asset sold by the personal representative. Beyond the issues of simplicity and fairness, we have a more fundamental reservation concerning the carryover basis proposal. A part of the tax (i.e., the tax on gain when the property is sold) is deferred until the sale. This, in combination with the addition to basis of the estate tax, makes it very difficult if not impossible to devise a revised estate tax rate structure which will properly reflect the additional tax attributable to carryover. ABA Alternative The ABA believes that if a change is to be made in the basis rule it should take the form of an additional estate tax (AET) on net unrealized appreciation included in a decedent's gross estate. The current basis rule for property included in a decedent's gross estate that gives such property an income tax basis equal to its estate tax value would be continued. The rule of section 1015(d) for property transferred during life would also be retained except that the part permitting an increase in basis for the gift tax paid which is attributable to the transferor's basis would be eliminated. The AET would be applied at a single flat rate. In contrast to the capital gains tax proposal, the tax would not be deductible in computing the basic estate tax. This fact justifies an AET substantially below the applicable capital gains tax rate or rates. The AET rate should reflect the complement of the highest estate tax rate and the highest capital gains tax rate. In this way a decedent whose estate is subjected to the highest estate tax rate would pay approximately the same AET as he would pay in capital gains tax under the capital gains tax proposal after the estate tax reduction resulting from the deduction for this tax is considered. All other decedents would pay a smaller AET than they would pay in capital gains tax under this proposal if exemptions were ignored. We visualize a reduction of the highest estate tax rate to 60%. Using this rate and the current capital gains tax rate of 35% but ignoring the minimum tax, the AET would be set at 14%--35% times 40% (100-60). A minimum basis equal to the estate tax exemption, currently $60,000, would be allowed. Thus, no AET would be owed by any decedent's estate not required to file an estate tax return. Certain assets, life insurance and annuity contracts, income in respect of a decedent and any item (a collection would be a single item) of tangible personal property held for personal use having a value of $5,000 or less would be deemed to have a basis for AET purposes equal to its estate tax value and thus would not generate any tax. A surviving spouse would be given an election to subject her share of community property containing net appreciation to the AET at the time of her spouse's death, in which case her basis would be increased to the property's current value. Property qualifying for the marital deduction would not be exempted from the AET. This does not necessarily mean that the sum of the basic estate tax and the AET would be greater than the current estate tax on an estate using the marital deduction. The lower basic estate tax rates plus acceptance of another recommendation of the ABA, to increase the amount of the marital deduction (discussed below), would act as an offset to the AET. A deduction could be granted in computing the AET based upon the percentage of the gross estate passing to charity. The ABA believes the AET would be the fairest and easiest method of changing the basis rule for property included in a decedent's gross estate. Nevertheless, it does not support enactment, but rather would prefer retention of the current basis rule. GENERATION-SKIPPING Current Law Under current estate and gift tax law, the tax imposed on a transfer of property does not take into account the status of the recipient of such property, except in the case of the marital and charitable deductions, and the termination of an interest in a trust, such as an income interest, is not a taxable event. Thus, a single transfer tax is imposed on outright transfers that skip one or |