Mr. KLEE. As the Service says, section 381 does not apply to divisive reorganizations.

Mr. PLUMB. Yes, and on its face it does not. On the other hand, the committee report on the 1954 Code says that this is without prejudice to whatever rule might be applied in any reorganization or in any area not covered by section 381.

Mr. KLEE. My next question relates to your statement on page 47, relating to "Tenancies by the Entirety." Earlier we had testimony that if a tenancy by the entirety could be disposed of in bankruptcy, that the nonbankrupt spouse should be compensated for that spouse's proportion of the tenancy by the entirety.

It occurs to me that there are two ways to value that spouse's interest; one is based upon actuarial computation of the probable life tenancy and contingent remainder; the other is based on contribution. The witnesses testifying at the time thought there was some way you could have both, a contribution and an actuarial test to value the nonbankrupt spouse's interest; but I do not readily see how you can have them both, and I wonder if you have any thoughts on that?

Mr. PLUMB. Well, I would think that you are going to have a conflict if you use both because the actuarial fact may be that the wife is 10 years younger and has a much longer life expectancy, yet she may have put very little into it. On the other hand, it may be a gift that was made 20 years earlier. So, I don't think contribution is really the relevant factor. I think the value of it-and the impression I get from the Commission Report, which is not too clear on this point, but they speak, I think, of a half interest at one point; but maybe that is simply a loose statement. A half interest simply is not what the spouse's interest in tenancy by the entirety is worth, it depends entirely on actuarial evaluation. I would say, assuming there was no fraudulent conveyance or the like, if that it was created in good faith years before, that the actuarial interest would be the proper

measure.

Mr. KLEE. If the approach to financing a reorganization is drafted along the lines that the Federal Government will support these rehabilitative efforts, do you have any objection to a reduction from income tax of the cost of administration of the reorganization proceeding?

Mr. PLUMB. You mean have priority, how do you mean?

Mr. KLEE. Part of the problem of the trustee in filing a tax return is that often it will be burdensome on the estate. An exemption could be included, or a deduction could be included in the tax return, so that the trustee would only have to file a return if the estate had income above and beyond the expenses of administration.

Mr. PLUMB. In other words, it has a net income, you mean.

Mr. KLEE. A net income.

Mr. PLUMB. I think that is a very desirable thing because that is frequently the situation. You and I have an obligation to file a return if we have any gross income, because the Government wants to look at those deductions. But here we have a situation where there is at least some court supervision, and under the Commission's bill there. would be Government employees carrying out the administration, and the Service ought at least be willing to accept the same accounting that the court accepts.

Therefore, if there is no net, it seems to me there is no reason to have to file a return; the account that is filed in the court is evidence enough on that basis, without the need for a return.

Mr. KLEE. Section 7-315 (d) of H.R. 31 deals with the subject of the adjustment of basis for debt reduction. The National Bankruptcy Conference has recommended that Congress impose the fair market value bottom as a limit on the reduction of basis. You touch on that in your statement, but I wonder if you would comment on your reaction to that suggestion.

Mr. PLUMB. It was adopted in 1940 as an emergency solution to a problem that was bad in the sense that they were being taxed on the debt adjustment even though the creditors took over the equity, and the same creditors who had made the forgiveness in effect were being improperly taxed on the amount they had given up. They put this fair market value floor in as a rough rule of thumb. But as it works out, the business that is in the best shape, the one whose asset value is still there, gets the biggest benefit and the least cost for having the debt reduced; and the one that is really going down the drain, practically, but is still trying to make it back, the one that has the lowest values, is the one that is penalized.

There is no logical relationship between the fair market value and the benefit derived from the carryover. In these inflationary times, there may never be a case where you reduce basis to fair market value because all values have gone up.

Mr. KLEE. There is some question in my mind about the Government's role as a secured creditor. I do not know if, when the Government imposes a tax lien, it can be fairly said that it is imposing it on an antecedent debt in the true sense of the term, because perhaps it is not possible for the Government to extract a tax lien within a reasonably contemporaneous time.

What is your position on the preference section if the Government seeks to become secured within 3 or 4 months prior to bankruptcy; do you think that is fair to the other creditors?

Mr. PLUMB. I can see merit. Of course, you are talking about a lien rather than priority in this situation.

Mr. KLEE. Exactly.

Mr. PLUMB. There is not that much difference, except to the wage creditor.

Mr. KLEE. Except to the priority for the costs of administration, and the priority for wage creditors; a very expanded wage priority is recommended in the new bills.

Mr. PLUMB. So, really, the people that don't have any warning, when suddenly somebody comes in 3 days before bankruptcy and files a lien, the people that are caught are the creditors who are behind that tax anyway, if it is a recent tax. So, I don't know if there is a great deal of benefit, but I can see merit in not permitting a lien to arise that is given added priority in the last few months before bankruptcy, to the extent that reliance does bear on it. If you had your 1-year priority cutoff, it could well make quite a difference to suddenly have the Service come in with a lien at the last minute, as distinguished from whatever rights the Service might have under the bill as it finally may be adopted.

I think recognizing a lien has some unfairness in it, so far as it's done in the last few months and the creditor has had no way of knowing.

Mr. KLEE. My final question relates to what I think is the crux of the problem. Do you think the Federal Government should be treated as a secured creditor in bankruptcy, or do you think it should be treated as an unsecured creditor?

Mr. PLUMB. Are you defining an unsecured creditor as one with a priority, as it has now, or as a lien creditor?

Again, it does not make a great deal of difference except to those two priorities in between.

Mr. KLEE. No; I am not talking about any priority at all. I am talking about it being treated on par with other unsecured creditors; unless before bankruptcy it gets a lien, assesses and takes possession of the property, in which case it will not have any claim, unless possession was possibly taken 3 or 4 months before bankruptcy.

Mr. PLUMB. Well, as a practical matter, the time in which the priority is protected and they are able to act under the bills, would be very short. As a practical matter, it can't be done.

Mr. KLEE. Assume it was left at 3 years.

Mr. PLUMB. There is not a great deal of gap between the lien and the priority in that situation. In other words, under 67c those two prime priorities are ahead of liens anyway, in the case of personal property; there is no real distinction between personal and real property, and I don't see justification for one in that situation. Congress really crossed that bridge almost 40 years ago when it adopted that provision that said if the property is still in the bankrupt estate at the time of bankruptcy, those two priorities should be even ahead of liens. They crossed part of the bridge by saying "personal property" but not "real property." That may not be a logical distinction. Whatever reason was given at that time might apply equally to both kinds.

So, again, it's a question of balancing the equities of the people that have to manage the estate, and the people that are least able to bear the loss, the wage creditors.

Mr. KLEE. Thank you, Mr. Chairman; I have no further questions. Mr. EDWARDS. Thank you, Mr. Klee.

Mr. Plumb, you were present when the views of the Internal Revenue Service, the Department of the Treasury, and the Department of Justice were presented to the subcommittee.

Mr. PLUMB. Yes.

Mr. EDWARDS. Do you agree with those statements?

Mr. PLUMB. Yes, in general; certainly in conclusion.

Mr. EDWARDS. You mention on page 3 of your oral statement, just in passing, the provisions in the Commission's bill providing for the nondischargeability of student loans. Do you agree with that?

Mr. PLUMB. Do I agree with the the provision, or the analogy I drew to it?

Mr. EDWARDS. You drew the analogy.

Mr. PLUMB. Yes, I think you have an abuse there, and I believe that's based on intention, isn't it? That they incurred the debt without intention to pay, something like that, and then went into bankruptcy to avoid it, that the debt should not be dischargeable. Certainly, as a minimum, if a taxpayer should set out to stall the collection--and it can happen-by filing a compromise offer, to keep the collector off hist back for 1 year and then get away free-free at least to the extent that he had spent all his assets.

Mr. EDWARDS. Do you think the nondischargeability presently existing of tax claims caused more bankruptcies, or fewer bankruptcies?

Mr. PLUMB. I have no way to make an empirical observation on that. It would seem to me that dischargeability is an inducement to bankruptcy. In other words, a man might not go bankrupt, but might find a way out of his situation, if he cannot get rid of those tax claims by doing it. It depends of course on the balance between debts for taxes and other debts. But one who is primarily indebted for taxes might very well be induced to avail of bankruptcy, especially with the liberal exemptions that are being provided.

Mr. EDWARDS. Well, under present law he might be induced to go into bankruptcy because of the nondischargeability of the tax claims, he might as well get rid of as much debt as he can, with the Internal Revenue Service and the Department of Justice on his neck; right?

Mr. PLUMB. Well, bankruptcy won't help him with the 3-year cutoff; bankruptcy won't help him now as much as if you would put the 1-year law into effect. Therefore, he is less induced as far as his debts are for taxes. Of course, he may have other debts and may be induced to go into bankruptcy with respect to them.

This, I think, adds a powerful inducement, especially with these new exemptions, it is a powerful inducement for bankruptcy for the person who is having trouble paying his taxes.

Mr. EDWARDS. I was interested on page 6 of your oral statement, you were criticizing, I believe, the commission's bill because it would adopt a uniform national system of property exemptions, and also provide exemptions for life insurance proceeds, rights in pension and profit-sharing plans, interests in spendthrift trusts, etc.

Mr. PLUMB. Yes.

Mr. EDWARDS. Are you providing us amendments that would close those loopholes?

Mr. PLUMB. I have not drafted anything. The articles cover the subject, and the prepared statement covers the subject.

Mr. EDWARDS. It is possible, then, for a very rich person to take advantage of some of the loopholes that you pointed out, go through bankruptcy, pay nothing to his creditors, and still remain very wealthy.

Mr. PLUMB. That is true, and in some States that has not been uncommon. I can't give you statistics, but certainly, in Texas you get 200 acres of rural land, and it doesn't matter what is on those 200 acres. There was a much publicized case with a $175,000 mansion, and oil wells, and things like that are totally free if you take advantage of the exemption. Up until now that has not affected the claim of the United States.

Mr. EDWARDS. And the same would apply to a spendthrift trust.

Mr. PLUMB. Spendthrift trusts have always been subject to collection of Federal taxes, and should be. Dean Griswold made that point in his book I don't know how many years ago. He said the Government is not the kind of creditor against whom you should apply this power of the ancestor, to let his son, or whoever, enjoy his benefits without paving taxes in the process.

Mr. EDWARDS. One of the problems we are going to face, though, is that the Internal Revenue Service collects such a small amount of taxes out of bankrupt estates. It is a small amount, and they can talk about it all they want to, and get into reorganization chapters. Of course they collect taxes if they get into reorganization chapters, that is not the issue here.

It is very possible they spend a lot more money in collecting these small amounts, relatively small amounts of money, than they collect. Mr. PLUMB. Of course, I have no way of assesssing how much it costs to have a man go down to bankruptcy court and file proof, and whatever else they have to do. And, of course, it's only in the larger cases where there is a great amount of effort involved. I assume that they take into account the $200 claim, they don't put 14 men on it full time. Mr. EDWARDS. You are talking about at least $300 million a year in claims, I think that was the figure in corporate plus individual claims; so, there is a lot of work done. It must be very expensive to send a man down to court if you do it on $300 million worth of claims, you are spending the taxpayers' money.

Mr. PLUMB. I expect there is a large concentration, in other words, there may be a limited number of large claims and a mass of small ones; but as a matter of fact, many times the Government refrains from proving its taxes, presumably because there are small amounts involved. This has been a problem, and there have been some recent decisions criticizing it, where they fail to file a proof of claim because the tax is nondischargeable and they can collect it more easily from the debtor's after-acquired assets without getting the bankruptcy judges into the tax matter; that is a serious problem, I think.

But in the larger cases, I think they spend commensurately with what the case warrants. I doubt that they do more than type out a piece of paper and send it down if it's a $200 claim.

Mr. EDWARDS. Mr. Parker?

Mr. PARKER. I just have one additional thought, Mr. Chairman, along the lines of inducement. As a practical matter, I know of a former client who had this problem. It is the Internal Revenue Service's claim, or the amount they owe to the Government that forces them into bankruptcy now. They try to deal with their accumulated debt which for any reason has occurred, medical expenses, a divorce, whatever it is, and failed to pay their income taxes on time, mostly in small businesses, small proprietorships. They try to deal with the Federal Government and the creditors at the same time. The Government knows they don't have to deal with them, their collection efforts, therefore, are rather stringent; and it's that collection effort that forces the person to take bankruptcy to get rid of the rest of his debt, so that he can at least pay Uncle Sam and that way get out from under. If in fact we changed that balance, so that the Government would have to take a payment plan of some kind, or that their collections would have to be modified in some way, that might allow some people who now file bankruptcies not to file and work their way out of

it in time.

I don't think that it's necessarily fair to say that everybody goes into bankruptcy just to get rid of their debts.

Mr. PLUMB. I don't think everybody does. I think that the problem exists in limited cases-say a prizefighter has a big fight and spent the winnings instead of paying his income tax-a case like that does get publicity. Say he went into bankruptcy to escape tax liabilities, and then goes on and has some more fights, and doesn't have to pay his back taxes. I think that would have a very bad effect on taxpayer morale. The next man is not going to go bankrupt, but he is going to find another way to reduce his taxes by cheating a little because he