of time which will actually be received over a longer period which led to the enactment of section 691 in the first place. The quotation creates a false impression. The major administrative problems relate not to bunching but to liquidity and valuation. 691 income is unique in that in many cases it is not marketable and/or difficult to value. The Studies recognize that liquidity is a problem. It is, therefore, difficult to understand why the Proposal accentuates this problem by accruing all payments in the decedent's final taxable period. The quotation also creates the impression that the complexities relating to 691 income will be removed if it is accrued at death. This is not the case. The same problems would continue to exist under an accrual concept. When the income in respect of a decedent will fluctuate in amount and is not payable upon the decedent's death (thus requiring a discount in taxing it in the decedent's final return) its receipt by the recipient will result in the realization of ordinary income (or an ordinary loss) under the Proposal. In such cases the Proposal does not simplify but rather complicates the taxation of 691 income since the slate is not wiped clean as of death. Further, in some cases the recipient might not be able to take advantage of any ordinary loss that would be available under the Proposal. (d) Net Losses The Proposal would permit any net unrealized loss at death to offset gains in the decedent's final taxable year, then to offset gains realized during the three preceding taxable years and finally, subject to certain limitations, to offset ordinary income for the year of death and the three preceding taxable years. Aaditional complexity and expense would result from refund claims while the benefit to be derived from refunds is lessened by the higher transfer tax as a result of any refund being an asset of the decedent's estate and increasing the gross estate. Further, when there is a net loss upon death, the benefit to be derived from it may depend upon the time of year during which the decedent died (which will affect his income for that year) and his income, including gains, during the preceding three years. Taxpayers in identical positions as to the amount of the net loss would be treated differently. The Proposal's handling of losses presents an obvious inconsistency between lifetime transfers and transfers at death. The Studies state (page 339): "Losses will be allowed on lifetime gifts under the same rules as apply at death. However, no losses will be allowed on transfers between related parties." The provisions regarding disallowance of losses on sales or transfers between related parties are found in section 267. Related parties include a transferor's brothers and sisters, spouse, ancestors and lineal descendants and a trustee of a trust created by the transferor. Thus, because of the broad scope of the term related parties, losses would not be allowed on substantially all transfers of property than an individual would desire to make. The provisions of section 267 are not applicable to estates. Estate of Hanna, 37 T.C. 63 (1961), rev'd, 320 F.2d 54 (6th Cir. 1963). Since losses will be allowed on transfers to related parties at death, a result of the Proposal is to penalize lifetime giving. (e) Start-Up Date The Proposal takes the position with respect to assets acquired prior to the enactment date that in computing gain basis will be the higher of (1) the basis of the asset immediately before death under current law or (2) its fair market value on the enactment date (adjusted under current law for changes occurring after that date) and that in computing loss basis shall be the lower of (1) or (2). Thus a taxpayer's actual basis for an asset (1) - will still be important even though the asset is not sold during his life. This introduces complexity and in some cases it will be impossible to establish actual basis. (£) Minimum Basis and Exclusions from Tax for Types of Property By allowing a minimum basis of $60,000, the Proposal exempts from tax a substantial amount of net unrealized appreciation. If the imposition of a capital gains tax on unrealized appreciation at death is sound, we question the advisability of creating such a liberal income tax exemption. Based upon the estimates referred to in the Studies (page 334), approximately 35% of the net unrealized appreciation passing at death is a part of estates not required to file an estate tax return. The fact that the Proposal's minimum basis coincides with the $60,000 estate tax exemption points up the close relationship between the capital gains tax at death and the estate tax. Both are taxes imposed on capital. The Proposal exempts from the tax all gain on ordinary personal and household effects of a value of less than $1,000 per item and provides that no loss will be allowed for personal and household effects. The per item exclusion is too low, and should be higher so as to minimize proof problems as to basis for should tangibles. The failure of the Proposal to permit losses to offset gains where the value of $1,000 is exceeded is unfair. (g) Source of Payment of Tax Under the Proposal, the net appreciation would be taxed "in the final income tax return of the decedent." While such an approach is understandable in the case of appreciation on property owned solely by the decedent at his death, it presents a problem regarding property that is not so owned, such as property held in an irrevocable trust or jointly held property. It would be unfair, and perhaps unconstitutional, to impose an income tax on net appreciation attributable to non-probate property against the decedent's probate estate when the beneficiaries of the non-probate property and the probate estate are different the tax should be imposed on the owner of the non-probate property. This solution would, however, be troublesome where, for example, the non-probate property has net appreciation but the property in the estate has a net loss in that the loss could not be used to offset the gain. 2. Effect on State Income Taxes The Proposal contemplates that "persons holding appreciated assets at death would be treated as if they had sold such assets just before death, and such gains would be taxed in the final income tax return of the decedent." A number of states have income tax statutes whose starting point in determining the state tax is taxable income for federal income tax purposes, with certain adjustments that do not include a reduction for capital gains. Thus, unless legislative changes were enacted in these states, which would be unlikely, the Proposal would result in not only a federal tax but also a state income tax on the gain. This is an undesirable result in that it would raise the "cost of dying" even higher. * If a surviving joint tenant has ownership rights in the property under applicable state law, it is questionable whether an income tax on the net appreciation in his or her share could be imposed as a result of the death of the deceased joint tenant. D. An Additional Estate Tax on Net Appreciation 1. General Explanation The most satisfactory way of taxing net appreciation at death is by the imposition of an additional estate (transfer) tax. The AET would be applied at a single 14% rate.to net appreciation included in (i) an individual's transfers at death and (ii) in his transfers made in the two years immediately preceding death unless the transferred property is sold before death. Thus the AET could not be avoided by a transfer "in contemplation of death". A minimum basis equal to the "exemption" for transfers at death would be allowed in order that no AET would be owed by any decedent's estate not required to file a transfer tax return. Current law carryover basis would be continued as to all other lifetime transfers. The credits applicable to the basic transfer tax would not apply to the AET. No exclusion from the AET would be available for property included in transfers at death and qualifying for the marital or charitable deduction. In the interest of simplicity, no special rule is established for depreciable property, including that subject to recapture under section 1245 or 1250. This simplified treatment contrasts with the treatment of such property under current Canadian law imposing a capital gains tax at death pursuant to which this property would be considered to have been sold for an amount midway between fair market value and the original cost less depreciation. Only appreciation occurring after the effective date of the AET would be subject to the tax. The start-up date would apply to each spouse's share of community property. The use of a start-up date will necessitate a gradual five year phase-in of the Section 1 basic transfer tax rates in order to prevent an immediate revenue loss. The choice between a start-up date with gradual basic transfer tax rate reduction and immediate full rate relief with use for AET purposes of actual basis will obviously affect individuals differently- the individual who dies shortly after the effective date of the Draft with little unrealized appreciation in his assets will derive no real benefit from the AET's start-up date, while the individual who dies at the same time with assets containing significant appreciation would probably be disadvantaged by the use of actual basis under the AET, regardless of an immediately effective full reduction in the transfer tax rates. On balance, we believe a start-up date is appropriate, mainly because it seems unfair to penalize persons who did not keep an accurate record of basis in reliance upon existing law. No benefit is provided under the AET for a tax rebate attributable to a net loss at death. Since a consequence of the AET is a reduction in the basic transfer tax rates, the decedent with a loss will still receive the benefit of a reduced tax imposed under Section 1 and will be better off than under current law. If it is deemed advisable to give relief to an estate with a net loss, this could be done (i) by permitting a reduction of the basic transfer tax in an amount that would be the equivalent of what the AET would have been if the estate's basis for its property had been its fair market value on the applicable valuation date reduced by the net loss or (ii) by permitting carryover basis, assuming that the decedent's basis may be substantiated. They are: An AET has three main advantages over the Proposal. Fairness. The effect of the tax is progressive as a result of the entire net appreciation being subject to both the basic transfer tax and the AET. Simplicity. The collection and administration of a tax on net unrealized appreciation at death would be simplified by combining it with the estate tax collection process since there would be a single collection and audit (involving the same valuations) by a single auditing agent. Constitutionality. Some people believe that the imposition of a capital gains tax on net un- a. The Method of Determining the Tax There is an element of double taxation in taxing appreciation at death if the full value of the estate is subject to transfer tax and the full amount of the net appreciation at death is subject to the AET. The Proposal avoids this result by allowing a transfer tax deduction for the capital gains tax. The logical way of avoiding this result in connection with the AET is to increase the basis of the decedent's property by the transfer tax attributable to the net appreciation before imposition of the AET. However, providing such a basis step-up in computing the AET introduces regression in the same manner as exists under |