-12 property. Section 2036 (c) specifically attacks business as opposed to personal wealth, illiquid as opposed to liquid assets and families as opposed to unrelated parties. It encourages business owners to sell to outsiders, rather than to family members, whenever sales of their interests are contemplated. Moreover, it is inequitable within the family context: it favors families whose wealth is represented by passive securities over those whose personal efforts had created the wealth in the form of an active business; and, it unfairly permits the parent who can give cash to a child to buy a business without adverse tax consequence. In the balance, the suspected revenue lost through abusive estate freezes is not worth the known damage to family business that Section 2036 (c) will cause. The amount forgone through estate freezes is a small portion of the amount taken in from estate and gift taxes and an extremely small portion of the total tax dollars generated from all sources. Section 2036 (c) should be seen for what it was intended to be: a device to assist the IRS in correcting valuation abuses in recapitilizations. It should not seek to accomplish this objective by prohibiting common sense transactions in estate planning; or, by a invoking a legislative panacea to enforcement concerns. It should limit itself to valuation questions, without interfering with business or family planning. If the transfer tax system is careful not to encourage the sale or break-up of family businesses, it must inevitably allow some build-up of future appreciation to pass unencumbered to the offspring. Again, Mr. Chairman, I greatly appreciate the opportunity to appear before you today and discuss this important issue. I commend this Committee and the Department of Treasury for working together with the business groups to seek an alternative to Section 2036 (c). The replacement proposal is a step in the right direction, not only because of certain substantive changes it proposes, but because of the process through which those changes were developed. I am hopeful that the spirit of cooperation shown here will be reflected in the final legislation and in the process of developing solutions to other potentially divisive issues. 3 According to the 1989 Commissioner's Annual Report, the total revenue generated from estate and gift taxes constitutes less than 1 percent of the total revenues collected in the U.S. For fiscal year 1989, some $8.144 billion were collected from estate taxes and $829 million from gift taxes, as compared with $1.013 trillion from all sources. Furthermore, according to the IRS, the net worth of estates with more than $500,000 contains much more than family business assets: Out of the gross estate of $36 billion, $8.4 billion was in real estate, $1.5 billion in notes and mortgages, $3.4 billion in bonds, $3.8 billion in cash, $1.7 billion in household goods and other assets, $9.9 billion in stock (publicly traded and private) and $1.7 billion in noncorporate assets. Chairman ROSTENKOWSKI. Mr. Apolinsky. STATEMENT OF HAROLD I. APOLINSKY, VICE PRESIDENT-LEGISLATION, SMALL BUSINESS COUNCIL OF AMERICA; AND PARTNER, SIROTE & PERMUTT, BIRMINGHAM, AL Mr. APOLINSKY. Thank you. I feel privileged to appear today on behalf of the Small Business Council of America. I am a tax lawyer, having practiced for over 25 years doing estate planning. For over 15 years, I have taught estate planning at both the Cumberland School of Law in Birmingham and the University of Alabama School of Law. As I sit here and listen to this, the testimony offered, and I consider the many hours of effort put in by your staff and by others, I am reminded of a wonderful book by Professor James de Bono, entitled "Lateral Thinking." He cautions that before we begin to solve a problem, before we look at alternatives and complexity, we move laterally to be absolutely sure we indeed have a problem. Because if we do not have a real problem, the solution is apt to cause the problem. My point is that I believe that we should have thought about de Bono's book in 1987. I do not think there was a real problem out there that needed to be addressed with 2036(c) and the type of effort that is being given to this. I have done maybe 20 freezes in my practice. With every one, I have used a qualified appraiser. My valuation would stand up under an IRS microscope. It bothers me that the fees of the appraisers exceeded the fees for the legal work in many cases, but I felt that was necessary. In teaching my classes, I have emphasized over and over again that tax lawyers doing estate freezes must engage quality appraisers. It is wrong to plan a client into a fight with the Internal Revenue Service. It is expensive and the client perceives that you failed and you will get fired. It is as simple as that. I do not believe my standard of practice is much greater or better than the standard of practice of anyone else in this country. Estate planners know that their products will be looked at by the Service. Every will that we do for someone who has had a freeze, when that person dies, that will, that estate tax return will be read closely by the Internal Revenue Service. If there is a problem with the value at that time, it will be picked up. That is why we are careful about doing it. I do not believe the level of abuses would rise to more than 1 or 2 percent. If there is need for more disclosure, the answer is to simply mandate disclosure of freezes on gift tax returns and require the furnishing of an appraisal with the return. When there was a valuation question raised about charitable gifts in the middle eighties, that is what you did. The appraisal and the notification, and that seemed to me to cure the problem. When you started in February, Mr. Chairman, focusing on simplification, I was excited because I love to count the number of code subsections that have been changed in the last few years. The eight major tax laws in the last 9 years have changed over 8,200 code subsections. My rabbi told me that tax law changes are intellectually stimulating and generate legal fees, and he is right. I asked him how he would like it if we changed the Torah every year. I think he understood my point of view. The proposed 2701, 2702 and 2703 are 25 pages in length, to replace a four-page statute that did not work. The four-page statute produced a 77-page notice in August of 1989. I would really urge that the first example of simplification be the repeal of 2036(c), without substituting chapter 14. Thanks very much for letting me share my thoughts with you. Chairman RoSTENKOWSKI. Thank you very much. [The statement of Mr. Apolinsky follows:] Statement of Harold I. Apolinsky For the Small Business Council of America Before the House Ways and Means Committee Concerning Proposed Chapter 14, Sections 2701, 2702 and 2703 Repealing 2036 (c) April 24, 1990 Mr. Chairman and Members of the Committee, my name is Harold Apolinsky. I am entering this statement into the record on behalf of the Small Business Council of America (SBCA), a nonprofit, nonpartisan national organization which represents the interests of small business organizations on Federal tax and employee benefit matters. SBCA is an organization of approximatley 1,000 small businesses, which provides a tax voice for the 17 million often overlooked small businesses in our country. With its leadership of tax experts, SBCA's primary goals are to prevent Federal tax laws from becoming more complex and burdensome for small businesses and their owners and to support legislation which creates needed economic incentives. I am the managing member of Sirote & Permutt, P.C., an Alabama law firm, and have been practicing tax law for almost 30 years. Over 65 percent of my practice is estate planning. For over 15 years, I have taught estate planning at both the University of Alabama School of Law and the Cumberland School of Law. I presently also serve as President of the Estate Planning Council of Birmingham, and have held leadership positions in the American Bar Association Section of Taxation, the Alabama Bar Association Tax Section and the American College of Tax Counsel. The subject of these hearings, Section 2036 (c) and the proposed modifying legislation, is of major concern to small business and farm owners. The outcome of your findings and whatever corrective measures you undertake, be they outright repeal which we advocate ΟΙ major simplification of this extremely complex, unwieldy and burdensome statute, will significantly impact many small business and farm owners who wish to pass ownership ultimately to their children. The Small Business Council of America applauds the efforts of those members of Congress, most notably Congressman Archer and over 200 Co-sponsors of H. R. 60, to repeal Section 2036(c). In the Senate, SBCA also applauds the bills to repeal Section 2036(c) introduced by Senators Boren, Daschle, Symms, Baucus and Heflin plus over 30 co-sponsors.' Section 2036 (c) was adopted, without any hearings in the House of Representatives or the Senate, to stop family business Owners from exchanging common stock which grows in value if the business becomes more valuable, for preferred stock which is frozen in value. This approach may have been first used by the DuPont family around 1935. It has been used by many family business owners for over 50 years. Unfortunately, proposed Chapter 14, new Sections 2701, 2702 and 2703, effect the same result as 2036(c). Parents will not be able to transfer businesses and farms to children without significant and devastating estate and gift taxes, at a level of over 50%. The vast will not be able majority of family businesses and farms to achieve a practical estate freeze if new Chapter 14 to the estate and gift tax laws is enacted. Owners will not be willing to commit to the cash flow mandated by the "qualified fixed payments". The alternatives provided will not help the owners. Thus, there will continue to be significant estate taxes levied on family businesses and farms preventing orderly transfers to family members. It is wrong to force corporations to either declare preferred dividends or face gifts or inclusions for the holders of preferred stock under proposed Section 2701. The advisability of paying dividends is a business decision by boards of directors and depends upon profits, working capital needs, plans for expansion, etc. The holders of the preferred stock frequently will not have voting control and should not make ΟΙ influence business decisions for their personal gain which might adversely affect other stockholders. They could be sued. The concept in 2701 of excusing dividends only in the event of bankruptcy or formal insolvency is thus flawed and should not be adopted. Section 2702, as a practical matter, rules out all meaningful buy-sell agreements for family businesses. Buy-sell agreements containing formulas which may ΟΙ may not equate fair market value at death are just as appropriate and necessary in family business situations as when the co-owners are not related. In fact, they may be more important in family situations. Such agreements are made when neither party is sure who will be the first to die, and thus contain safeguards from the marketplace, without the need for more statutory prohibition and rules. For 25 years, the regulations under Section 2031 of the Estate Tax Law have set forth comprehensive rules governing buy-sell agreements. Regulations Section 20,2031-2(h) provides in part as follows (more complex rules are not needed): "Even if the decedent is not free to dispose of this Section 2703 creates another set of family attribution rules. In fact, there are two new sets in Chapter 14. Add this to the sets in Section 318 and 267, plus other provisions, and we may now be to an approximate total of ten different sets of family attribution rules. Those of us working with the SBCA and other groups representing family businesses and farms were encouraged and excited when Chairman Rostenkowski, Congressman Archer and others a few weeks ago spoke of the need for simplification of the Tax Code. Individuals and especially owners of family businesses and farms can no longer cope with the complexity of the Code and the number of complex provisions and changes. Since 1981 the following changes have occurred: |