selling during life. Such a solution might be a transfer tax credit for certain capital gains taxes, which is contained in H. R. 3068 that was introduced by Representative Broyhill.

Two changes in the current basis rule have been widely discussed. The first is to impose an income tax on unrealized appreciation at the time of transfer, whether during life or at death and, if the transfer is made at death, to allow a deduction in computing the estate tax for this income tax.

The second suggested change is to carryover the decedent's basis for his property to the beneficiaries receiving this property as a result of a transfer at death, and to increase the basis of each asset having unrealized appreciation by its proportionate share of the estate tax imposed upon the net unrealized appreciation in all estate assets. Thus, the basis rule for transfers subject to estate tax would, in general, be the same as the present basis rule in section 1015 (d) for transfers that are subject to gift tax. The reason for increasing the decedent's basis by the part of the estate tax attributable to the net unrealized appreciation is to prevent a double tax estate tax and an income tax - being imposed on an amount equal to that part. The capital gains tax at death proposal eliminates the double tax in a different manner by granting an estate tax deduction for the income tax on the net unrealized appreciation at death.

- an

Any change in the basis rule will introduce more complexity into the administration of estates and therefore increase the time required to administer them and the costs of administration. Current law has the virtue of simplicity since basis becomes irrelevant upon death and problems of proof of basis disappear.

We oppose any change in the basis rule unless

it is accompanied by

a.

A reduction in current estate tax rates so that the "cost of dying" is not increased;

b. A liberalization in the rules with respect to proof of basis so that if the facts necessary to determine basis are unknown it will be the fair market value as of the date (or approximate date) when the property was acquired by the decedent; and

C. A current "start-up" date so that property owned by an individual on the effective date of the change would be given a new basis equal to its current market value for the purpose of applying

the change to property owned at death.

Assuming these three conditions would be satisfied, we favor taxing unrealized appreciation at death to carryover basis. We have, however, rejected a capital gains tax at death in favor of an additional estate, or transfer, tax (AET) on such appreciation. This tax would apply to property transferred at death and to property transferred within two years of death if it is not sold prior to death. The AET would not apply to other lifetime transfers, as to which carryover basis would be continued.

Some people will say that the AET is nothing more than a capital gains tax at death in disguise. They are correct in the sense that the result is the same the taxation of net unrealized appreciation at death. However, as will be explained in detail below, there are significant differences between these two approaches to taxing such appreciation. These differences are so important to us that if the choice were only between a capital gains tax on net appreciation transferred during life or at death and carryover basis we would favor carryover basis. In order fully to understand our reasons for preferring an AET, it is necessary to examine in detail the capital gains tax and carryover proposals.

B. Carryover Basis

The carryover basis concept would raise a number of problems, regardless of the exact form the statute would take.

Determining Basis. Under existing law basis becomes irrelevant upon death. Accordingly, many persons have not maintained satisfactory records with which to establish basis. Any change to a carryover basis rule would work to the disadvantage of and produce hardships for individuals who acquired assets from such persons. Fairness requires that any carryover basis rule should permit a person acquiring property at death that (i) was owned by the transferor on the date of enactment of the rule or (ii) was owned by another person on such date who transferred it by gift to the transferor after that date to use as the transferor's basis the property's value on that date for the purpose of computing gain (but not loss).

Administrative Complexity and "Suspended Basis". If an estate consists of a number of assets, the allocation of the increase in basis attributable to the estate tax may require a considerable amount of time. Further, this increase will be uncertain ("suspended") until the estate tax is finally determined and by that time there may have been a number of sales of assets and the income tax returns reporting these sales will have to be readjusted to determine gain or loss to reflect the change in the final estate tax figures.

"Lock-In". Carryover perpetuates rather than solves the "lock-in" problem. It is clearly a less satisfactory solution to this problem than current law or a tax on net unrealized appreciation at death, which have the effect of freeing up the flow of capital assets no later than at death. Carryover has this effect only to the extent that appreciated property must be sold after death to raise funds with which to pay death taxes, administration expenses and claims.

No Satisfactory Way to Increase Basis. There is no simple and fair way to provide for an increase in basis for the estate tax attributable to the net unrealized appreciation when a marital deduction, or community property, is involved. Under the carryover proposal, the basis of all estate property (including the qualifying for the marital deduction or the surviving spouse's share of the community property) would be increased by the estate tax attributable to net appreciation.* This 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 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 would 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 or the decedent spouse's share of community property will be lower than it would be if the entire increase were allocated to such property.

In a non-community 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

See, for example, Section 106 of H. R. 1040 (The Tax Equity Act of 1973).

time sales will be made 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 is penalized because under existing practice sales of community assets to raise funds for taxes, administration expenses and community debts to involve both halves of the 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.

Mushroom Tax Effect of Carryover.

In many cases,

one being where the estate consists of "one asset" - a farm or a closely-held business which cannot be divided for sale to meet its obligations, the effect of the carryover basis rule may prove little different from a tax on net appreciation at death. In order to raise funds to pay the estate tax, the executor will realize capital gains and will then have to make additional sales to pay the income taxes on the gains, thus creating a "mushroom" tax effect. To the extent that capital gains must be realized in order to raise funds with which to pay the estate tax, carryover amounts to a partial capital gains tax at death.

Funding Marital Bequests. There are two basic types of marital deduction formula clauses pecuniary (fixed sum) amount or fractional share. Under current law, satisfaction of a pecuniary clause with appreciated property results in a realization of gain in an amount equal to the difference between the basis and current value of the property when distributed. The recipient takes over new bases for the distributed assets equal to their date of distribution values. Many lawyers prefer this type of clause to the fractional share clause because it simplifies administration. The gain problem could be very serious under carryover basis. While it could be cured by changing the income tax law so as not to treat the satisfaction of a marital bequest in a pecuniary amount as a taxable transaction, this solution would not be entirely satisfactory since the executor in funding the bequest could affect the rights of the beneficiaries significantly by his choice of the property that he selects in that he may use "high" or "low" basis property. The fiduciary duty of impartiality might suggest that the executor would have to make a pro rata division of basis between the marital and non-marital portions of the estate. Such a requirement would produce complexity in making partial distributions and tend to remove one of the primary advantages of the pecuniary bequest, namely, simplicity.

Net Tax Increase. A serious reservation that we

have regarding carryover is that its enactment would not be accompanied by a significant reduction in transfer tax rates applicable to transfers at death. Under carryover a part of the tax (i.e. the income 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 on net unrealized appreciation, makes it very difficult to devise a reduced rate structure which will properly reflect the additional tax attributable to the carryover.

C. Capital Gains Tax on Net Unrealized Appreciation

The Proposal

A capital gains tax at death was proposed by the Treasury Department in the 1963 hearings before the Ways and Means Committee and was rejected. It was resurrected in slightly modified form in the Studies. The major elements of this most recent proposal (the Proposal) are:

1. The decedent's final income tax return would include all appreciation on capital assets as if the assets had been sold immediately prior to death. Also, the unrealized appreciation in property transferred by gift rather than at death would be subject to income tax at the time of the transfer.

2. Unrealized losses on capital assets would be allowed on the decedent's final return and if the losses exceed gains an offset would be allowed against capital gains for his three prior taxable years and then against ordinary income for the year of death and three prior years. Losses on lifetime gifts would also be allowed except as to transfers between related parties described in section 267.

3. All gains would be long term regardless of the holding period.

4. The income tax on the gains taxed at death would be deductible in computing the estate tax payable.

5. Only appreciation occurring after enactment would be taxed. With regard to assets held on the enactment date, in computing gain the taxpayer could claim as his basis the higher of actual basis or value on the enactment date and in computing loss the taxpayer would use the lower of actual basis or value on the enactment date.