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A 14-year period for the payment of interest and gift tax on a defined major gift involving a intergenerational shift in ownership of an operating business or farm. At death, these payments would be liabilities of the estate.
A federal taxable gift election by a transferor for his interest in an entity or equity, with payment of the gift tax deferred until the transferor's death. These payments would be liabilities of the estate.
An elective federal gift and estate tax value for transfers of common or residual equity interests in an operating business or farm, based on a market rate discount of the forecast income stream of the interest, i.e., use the Chapter 14 methodology to value the interest transferred.
A substantial part of the revenue loss from transfer taxes in prior years relates to trusts, split purchases of investment instruments and use of the holding corporation or partnership structure to hold investment instruments. The component of the revenue loss from investment instrument transactions will become more significant in future years if there is no remedial legislation.
It is doubtful that the classic transfers of residual equity interests in operating businesses or farms in an intergenerational transactions resulted in significant net revenue losses. Unlike an investment instrument, the revenue loss from an estate freeze transaction for an operating farm or business may or may not occur, depending upon operating results of the enterprise. Freeze transactions involving investment, particularly debt, instruments always result in revenue losses.
The potential revenue loss from repeal of $2036(c) may be already substantially diminished as to operating business and farm enterprises. The extensive conversions from C corporations to S corporation status in 1986 removed the converting corporations from the classic preferred stock recapitalization freeze system. Integration of corporation and shareholder taxation may involve an enlargement of S corporations with a similar effect.
A debt freeze can be accomplished in a Subchapter S regime but the debt issue entails a Federal income tax toll charge upon the exchange of the equity interest for the debt interest in the enterprise. Issuance of the debt may not be an "exchange" transaction, i.e., may be a dividend equivalent so that the entire amount of the debt sourced on earnings and profits, is subject to income taxes and not merely the excess of the value of the debt over the adjusted basis of the stock surrendered by the transferor.
There is a revenue gain when $2036(c) induces the family to sell or liquidate an operating business or farm rather than transferring the enterprise to the next generation. This income tax gain may be partly offset by lower estate values from elimination of the family farm or business enterprise. Further revenue losses may result when the family enterprise is acquired by a larger concern, with loss of income tax revenues from terminated employees, heavy interest charges incurred by the acquiring company and special charges for shutdown of business activities.
There may have been modest income and gift tax revenue gains from transactions undertaken during the correction period provided in TAMRA (Technical and Miscellaneous Revenue Act of 1988) $3031(h)(4), to recast retained interests into the statutory safe harbors of $2036(c)(7) or in some cases to unwind freeze transactions. However, we believe these correction transactions may have been infrequent because of a public perception that $2036(c) was improvident legislation, which Congress was likely to reconsider.
The unnatural requirements of the TAMRA startup loan safe harbor that the transferor (lender) not participate in the enterprise and not transfer business opportunities to the
enterprise and that the transferee be an active participant in the enterprise has discouraged start up firms and decreased income tax revenues. In addition the qualified debt safe harbor enacted in TAMRA may have encouraged shifts from equity to debt interests in enterprises, reducing income tax revenue through interest expense deductions.
Federal gift tax revenue will be enhanced, if Chapter 14 is enacted, by permitting freeze transactions by gift, as well as the "in effect" or Dickman gifts for missed QFP payments. Federal income tax revenue will be enhanced by permitting freeze transactions by sale and by the payment of non-deductible preferred dividends. Estate tax revenues will be enhanced from the elective compounding of missed QFP payments in valuing the preferred equity interest in the entity upon death of the transferor.
The proponents of changes in the transfer tax system give insufficient effect to the long-range revenue gains from the 1976 Tax Reform Act. These proponents point to the decrease in revenues after 1977, which reflected the substantial gift tax payments made on 1976 returns reporting gifts made by donors in anticipation of the 1976 Act adjusted taxable gift provisions. Transfer tax revenue since 1977 has also been reduced with the unlimited marital deduction, the escalating unified credit equivalent exemptions and higher annual exclusions, including the medical and tuition exclusions.
In future years all of these revenue loss factors will be more than offset by gains from taxation at death of adjusted taxable gifts made after 1976, the pyramiding of property in the estates of surviving spouses, the effect of inflation and accumulated income between the dates of death of the first spouse and of the surviving spouse, the high Federal estate and gift tax brackets, the increase in individual wealth from lower Federal income taxes, inflation and a relatively strong economy and overall transfer tax rates twice the income tax rates.
In summary, $2036(c) should be retroactively repealed. Significant modifications should be made to the proposed Chapter 14 so that its provisions will be workable. Consideration should be given to enactment of Chapter 14 merely as a safe harbor elective by the taxpayer, and a study should be instituted of statutory revisions to facilitate lifetime transfers of interests in family owned businesses and farms preventing abusive estate freezes.
Chairman ROSTENKOWSKI. Mr. Archer
Mr. ARCHER. I apologize for not being present. As was your case, I was in a meeting with the President at the White House.
I want to tell the witnesses I regrettably could not be here at that time. If I had been here, I would have made the following statement, which, Mr. Chairman, I would like to be inserted, if appropriate, at the beginning of the proceedings.
[The statement is at the beginning of the hearing.]
Chairman ROSTENKOWSKI. Mr. Wallace, I noted in your testimony you submitted your proposal to Treasury and the Joint Committee on Taxation.
Some of the staff on the Ways and Means Committee would like to see your proposal.
Mr. WALLACE. We will include them as well. [The following was subsequently received:]
May 25, 1990
Robert J. Leonard, Esq.
Dear Mr. Leonard:
We are enclosing ten copies of the supplementary written comments with respect to the discussion Draft of Chapter 14. The written testimony of John A. Wallace, Esq., the Division Director of the Probate and Trust Division of the Real Property, Probate and Trust Law Section of the American Bar Association, filed on behalf of the American Bar Association ("ABA") was submitted to the Ways and Means Committee for the April 24 hearings. We stated in that testimony that we would be filing additional technical comments.
The comments that follow should be read in conjunction with John A. Wallace's written testimony, as well as with the written testimony of Jere D. McGaffey, Esq., the Chair Elect of the Section of Taxation of the ABA, filed on behalf of the ABA and the written testimony of E. James Gamble, Esq., filed on behalf of the American College of Trust and Estate Counsel. The three groups compose a Joint Task Force which was formed in 1988 to develop an alternative to Section 2036(c). All three groups prepared their testimony in concert and divided the topics among the groups.
Sloyd Lena Plaine
Lloyd Leva Plaine, Esq.
May 25, 1990
Supplementary Technical Comments
Chapter 14 on Behalf of the
of the American Bar Association
The written testimony of John A. Wallace, Esq., the Division Director of the Probate and Trust Division of the Real Property, Probate and Trust Law Section of the American Bar Association filed on behalf of the American Bar Association ("ABA"), with respect to the Discussion Draft of Chapter 14 was
submitted to the Ways and Means Committee for the April 24
We stated in that testimony that we would be filing
additional technical comments.
The comments that follow should be read in conjunction
with John A. Wallace's written testimony, as well as with the
written testimony of Jere D. McGaffey, Esq., the Chair Elect of
the Section of Taxation of the ABA, filed on behalf of the ABA
and the written testimony of E. James Gamble, Esq., filed on
behalf of the American College of Trust and Estate Counsel.
three groups compose a Joint Task Force which was formed in 1988
to develop an alternative to Section 2036 (c).
All three groups
prepared their testimony in concert, and in order not to be redundant, we divided the topics among the groups. Therefore, it is necessary to read all three written testimonies to see the
full scope of our jointly submitted substantive and technical