with the result that the basis for this spouse's share would be one-half of the total basis for the community property immediately prior to the other spouse's death. The second approach has been used, except that an election has been given to the surviving spouse to subject her share of the community property to tax at the AET rate of 14%. If an election were made, current law providing for an increase in basis would be continued for his or her share of the community property. An election is appropriate because in some cases the death of one of the spouses will virtually compel the sale of community property and it would be unfair not to permit the surviving spouse to take advantage of the AET if it would produce a lower tax on her share of the property sold. The AET which becomes payable by reason of the surviving spouse's election would be chargeable to her share of the community property.

If the surviving spouse makes an election, the AET on her share of the community property that is subject to the tax is computed separately from the AET on the deceased spouse's property. This separate tax computation makes it impossible for the surviving spouse to make an election for the purpose of reducing the deceased spouse's AET by using a loss on the surviving spouse's share of community property to offset a gain on the deceased spouse's separate property. The surviving spouse's AET is under the specific language of subparagraph (A) to be computed by use of the same valuation method used by the deceased spouse date of death or the alternate valuation date.

The election is available regardless of the type of community property involved. Thus, it could be used by the husband when the wife died first for pre-1927 California community property even though the wife has only an expectancy in such property or by a husband in any other community property state where the wife also has only an expectancy.

The

Two limitations on the election are provided one in subparagraph (A) and one in subparagraph (B). first of these a procedural matter - provides that the election must be made no later than the date for the filing of the deceased spouse's transfer tax return. It is anticipated that the regulations would prescribe the method of making the election. The most satisfactory method would appear to be that used for the election of the alternate valuation date checking a box on the transfer tax return and the signature of the spouse on the return.

The second limitation, a substantive one, has been imposed as a result of the term "(held as of the date

of the deceased spouse's death)" in subparagraph (A), which means that the election is not available with respect to community property that is transferred prior to the death of the deceased spouse. Thus, if the deceased spouse's share of community property is subjected to the AET by reason of a transfer within two years prior to death, his spouse is not permitted the election of subsection (a) (2) with respect to her share of any community property transferred before death. No hardship can result to the surviving spouse in such a case since she does not own the property at death.

It

Subsection (b) provides the general rule to be used in determining the basis of the decedent's assets. is separately stated for the decedent spouse and the surviving spouse's share of community property. The only difference between the treatment of the two spouses is that the surviving spouse is not entitled to use the minimum basis provision contained in subsection (b)(1). The total basis for all transfers covered by subsection (a), determined under subsections (b), (c) and (d), is subtracted from the total value of such transfers on the date of death to arrive at the amount of net appreciation subject to the AET.

For basis purposes, the assets are divided into subsection (c) assets and all other assets. The basis of subsection (c) assets is their fair market value on the application valuation date. The basis of all other assets will be the greater of (i) the aggregate of the assets' individual bases in the hands of the decedent immediately before death or (ii) $100,000 reduced by the aggregate of the amounts previously allowed as a specific exemption under Section 12 with respect to transfers made more than two years prior to death. The minimum basis under (ii) may not, in contrast to the Proposal, be used against ordinary income items.

Subsection (c) exempts from the AET (i) each item of tangible personal property held by the decedent for personal use and having a value on the valuation date of no more than $5,000 and (ii) all other items of tangible personal property having a value on the valuation date of less than the decedent's basis. The effect of these two "exemptions" will be to remove substantially all tangibles from the operation of the AET. This removal is a two-way street in the sense that no gain or loss is involved on

exempted items. In applying (i), items normally sold as a unit would be treated as a single item. Examples would be a stamp or coin collection.

Consideration was given to imposing a dollar ceiling on the total value of tangibles held for personal use with net appreciation that would be exempted from the AET. Such a limitation was rejected because of the complexity that would be produced in cases where the tangibles were left to several persons and an allocation of the exemption would be required. Further, as a result of items normally sold as a set or collection being treated as one item the significance of a dollar ceiling is substantially reduced. As a practical matter, it would seem that the application of the AET to tangibles would be limited to works of art, jewelry, rare books, stamp and coin collections and rare furniture.

Certain other assets which are subject to special rules for income tax purposes, namely, life insurance (section 101), annuities (section 72), and income in respect of a decedent (section 691), are exempted from the AET. This exemption will have no effect on the income tax treatment of the exempted assets. A type of income in respect of a decedent, pension and profit sharing benefits, is specifically mentioned in order to make it clear that such benefits will continue to be subject to both income tax and transfer tax. The inclusion of pension and profit sharing benefits as income in respect of a decedent is consistent with the holding of Hess v. Comm'r, 271 F.2d 104 (3rd Cir. 1959). Cash is also referred to in order that it does not enter into the computation of the minimum base.

Subsection (d) provides a "start-up" date for the computation of the AET and gives a current basis for property acquired prior to the effective date of Section 2. The basis of all such property will be the fair market value of the property on the effective date of the section, as adjusted in the normal course under section 1016 for the period after the effective date up to the decedent's death. Thus, the use of actual basis is eliminated in this area. Those who have such records will suffer under subsection (d) if their capital assets depreciated in value prior to the effective date of Section 2, but the advantages to be gained through simplicity in the statute and through the minimization of problems in the proof of basis area for such previously acquired assets outweigh the hardship to those who have a provable basis for assets on the effective date in excess of an asset's fair market value on that date.

Section 3. Taxable Transfers Other Than at Death

This section is the general provision taxing transfers other than at death. It replaces section 2503 (a), defining the term "taxable gifts", and includes the limitation of section 2512 (b) with respect to transfers made for less than a full and adequate consideration in money or money's worth. Sections 2511(a), stating that the gift tax applies to all types of transfers of all types of property, and 2512 (a), stating that the amount of a gift of property is the value of the property on the date of the gift, are omitted as unnecessary. Section 3 is supplemented by the specific provisions on includibility in Sections 4 through 10 of the Draft. Once the amount of transfers has been determined, taxable transfers are computed by reducing the value of such transfers by the amounts of any applicable annual exclusions under Section 11 and by the amounts deductible under the lifetime specific exemption, for transfers treated as transfers at death, and as marital or charitable deductions (Sections 12 through 15 of the Draft). The rate schedule of Section 1(b) is then applied to the resulting figure.

The last sentence of Section 3 provides that a promise to make a gift will not constitute a transfer under this section, whether or not the promise is enforceable under the applicable local law. The term "promise" includes a pledge and any other commitment to make a transfer deemed to be gratuitous, unfunded or unsupported by adequate consideration. The transfer occurs when the promise is fulfilled by an actual disposition of the subject property by the transferor. This provision is included in Section 3 to avoid problems similar to those posed by Rosenthal v. Commissioner, 205 F.2d 505 (2d Cir. 1952), Commissioner v. Estate of Copley, 194 F.2d 364 (7th Cir. 1952) and John D. Archbold, 42 B.T.A. 453 (1940). Current law remains unclear as to whether a promise to make a future transfer which is supported by consideration and is binding under state law is itself a transfer subject to the gift tax. See Treas. Reg. $25.2511-2; Revenue Ruling 69-347, 1969-1 Cum. Bull. 227. The ruling held that, at least where the value of the gift may be determined through recognized actuarial principles, the gift was complete for gift tax purposes in the year when the taxpayer became legally obligated to perform under the terms of his agreement.

The ALI Project (pages 79-80, 93-94, 157-61) proposed no changes with respect to the subject matter of Section 3. The Studies (pages 361, 369, 382) similarly proposed no changes in the subject matter of Section 3, except

for its recommendation of "grossing up" for lifetime transfers, which is discussed in connection with Section 1.

Section 4. Certain Property Settlements

Section 4 is based upon section 2516 and exempts from transfer tax certain lifetime transfers between spouses in settlement of marital and property rights and for the support of their minor children. As to transfers between spouses, it is needed because the Draft does not permit an unlimited marital deduction.

Section 4 provides that, where a husband and wife enter into a written agreement relative to their marital or property rights, any transfers pursuant to the agreement (1) to either spouse in settlement of those rights, or (2) to provide a reasonable allowance for the support of their children during minority will be deemed transfers made for a full consideration, and thus will not be taxable. In the case of a transfer under (1), Section 4 will be applicable only if the spouses live apart continuously for at least two years after the agreement is executed.

The general rule under current law is that a relinquishment or promised relinquishment of marital rights such as dower, curtesy, or a statutory election in lieu thereof does not constitute to any extent a consideration in money or money's worth. Treas. Regs. $25.2512-8. Thus a transfer in exchange for such a relinquishment or promised relinquishment is subject to the gift tax. If the spouses execute a written agreement, however, and a final decree of divorce is rendered within the two years following the execution, section 2516 provides that interspousal transfers pursuant to the agreement in settlement of marital rights or for the support of minor children will not be taxable as gifts.

Section 4 deletes the requirement of divorce from section 2516, and substitutes the requirement for interspousal transfers that the parties live separately for the two years immediately following the execution of the agreement. This conforms the lifetime consequences of these transfers with the treatment accorded them under Section 29 at death--in each case, they are not taxed. There is no sound reason for differing treatments of these payments dependent on when they are made.

The decision to exclude payments made pursuant to a written separation agreement from taxable transfers also brings their treatment under the transfer tax in line with

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