BB AMERICAN FARM BUREAU FEDERATION 225 TOUHY AVENUE PARK RIDGE ILLINOIS 60068 (312) 399-5700 600 MARYLAND AVENUE SW SUITE 800 WASHINGTON, DC 20024 (202) 484-2222 May 1, 1990 The Honorable Dan Rostenkowski, Chairman House Ways and Means Committee U.S. House of Representatives Washington, D.C. 20515 Dear Representative Rostenkowski: This letter is in reference to the committee's hearing on April 24, 1990, dealing with estate freezes. We ask that our comments be included in the hearing record. Farm Bureau represents over 3.8 million member families. The vast majority of them are farmers and ranchers who plan one day to turn their business operations over to their sons and daughters to continue the family business. Farm Bureau members have long recognized that estate taxes can be a major stumbling block in continuing the family business. It has been all too common that farmers and ranchers have had to sell part of the estate to pay the taxes. This has meant the dissolution of the business and has prompted Farm Bureau to maintain a policy of opposing the estate tax. To minimize the effect of estate taxes, many farmers have used estate planning including estate freezes to pass the farm to the next generation. As you have heard in recent months, Section 2036(c) and the vagueness of the provision have severely limited the ability to use estate freezes as a way to minimize estate taxes. It is our understanding that no widescale abuse of estate freezes occurred in agriculture or small business. We believe that Section 2036(c) is unjustified. Farm Bureau urges the committee to repeal Section 2036(c). While its benefits to the government are questionable, the havoc it plays with the orderly transfer of family business from one generation to the next is undeniable. Thank you for your consideration of our views. Sincerely, Joh Datt John C. Datt Executive Director JCD/lh ASSOCIATED BUILDERS AND CONTRACTORS TESTIMONY ON THE "DISCUSSION DRAFT" TO REPLACE SECTION 2036 (c) RELATING TO ESTATE VALUATION FREEZES Associated Builders & Contractors appreciates this opportunity to present its views on the current estate valuation rules under Section 2036 (c) and the replacement "discussion draft" under consideration. ABC represents over 18,000 contractors, subcontractors and suppliers who are united by the Merit Shop philosophy of management. Our membership, like the construction industry as a whole, is dominated by small, family-owned firms. Over 80 percent of our members do less than $10 million in construction volume per year. We would first like to commend Chairman Rostenkowski and the Department of Treasury for giving the business community the opportunity to participate in the formulation of this important and highly complex issue. The product of this kind of cooperation and public debate could serve as a model for other legislation and no doubt lead to better tax law in the future. Mr. Chairman, the continued growth and prosperity of familyowned business require that Section 2036 (c) be repealed. This provision of the tax code jeopardizes the ability of contractors to pass their businesses on to their children something our members believe is a fundamental right and essential to the economic strength of the nation. Indeed, estate planning professionals testified last year before the Senate Banking Committee that section 2036 (c) should be repealed and any substitute legislation should be delayed until Congress can examine the entire transfer tax system and its effect on small business. Construction contractors' businesses clearly cannot survive when up to 60 percent of the value of their firms are lost to taxes each time a generational transfer is made. Efforts to repeal section 2036 (c) have progressed in a truly bipartisan fashion. Congressman Archer's bill to repeal this rule has 218 cosponsors, and several bills have been introduced in the Senate which also repeal section 2036(c). In fact, the Senate Finance Committee approved repeal during its consideration of the budget reconciliation bill last year. Section 2036 (c) was added to the Tax Code in 1987 to stop perceived abuses in estate planning techniques. Despite its intensions, its impact was far greater than that. This provision prohibited common transactions for transferring company assets, favored those families whose personal assets were in securities investments rather than business ownership,. discouraged the participation of the children in the business, and drastically raised the costs of transferring ownership. So much so that contractors' businesses would have to be sold or liquidated by their children to pay the estate taxes upon his death. If ever there was a provision in the tax code to limit the financial life of a successful firm and discourage small business growth, its section 2036 (c). THE DISCUSSION DRAFT Any replacement for section 2036 (c) must guarantee that successful closely-held businesses can continue to flourish from generation to generation. It should also ensure that estate and financial business planning can proceed with unambiguous and consistent rules and guidelines. The discussion draft makes some major strides toward that goal. It recognizes the legitimacy of "freeze" transactions and does not transfer the appreciation of the founder's surrendered interest into his taxable estate. It also addresses the perceived valuation problem which gave rise to section 2036 (c) by approaching valuations properly as gift taxes rather than estate taxes. Although there are elements of the draft that are acceptable, there are many flaws as well. To start, the proposal is too broad in scope and consequently overly complex. Its restrictive valuation process would be very difficult to administer and thus make ordinary business transactions too costly for family-owned firms. Specific concerns are outlined below: o The proposal should not apply to buy-sell agreements. These agreements, leases, debt and other business arrangements should not be the single criteria for a valuation system. Buysell agreements are used by most closely held businesses. The true value of property would be determined without considering any option or agreement when the rights are exercised unless the price formula for determining value is reviewed. This provision applies to all buy-sell agreements of greater than three years duration regardless of whether they are connected to estate valuations or not. It would be especially burdensome in the construction industry where equipment and other capital expenditures would be subject to review every three years by the IRS. ABC is concerned that the valuation formulas imposed in this provision would not accurately reflect the market value of the contractor`s assets. Most of our members would not have the time or inclination to engage in the kind of sophisticated estate planning that would be necessary to comply with this rule. The costs of complying with this administrative burden is unnecessary and fails to take into account how small businesses operate. o Restrictions are too severe on the ability to withhold dividend payments to the founder, known as Qualified Fixed Payments (QFPs). The exceptions do not adequately reflect economic, financial or other legitimate business reasons for delaying such payments. ABC believes that such exceptions must be allowed in cases where a construction contractor`s surety bonding capacity is threatened. The payment of OFPs in cases where equity levels would be severely diminished below bonding requirements means these contractors would be unable to compete for projects they would normally bid on. This downsizing of the firm would be self-fulling prophecy. The assigned dividend The rate becomes tougher to meet as the firm's revenues fall. firm's revenues fall because its bonding capacity is reduced. The contractor's bonding capacity is reduced because the QFP requirements are eating up retained equity. Expansion becomes much more difficult, if not impossible as the contractor cannot meet his financial obligations. Once this scenario is put in motion, the contractor's recourse is to declare bankruptcy or insolvency -- one of the acceptable exceptions! o A related concern is the requirement that the valuation of founder's retained interest be based almost exclusively on the market rate of the fixed cash distributions. It is likely the founder's preferred stock dividends must be set as high as the company's debt. To set it any lower would result in a gift tax penalty because the exchange was not equal. According to the American Institute of Certified Public Accountants, since dividends are nondeductible, the familyowned corporation must earn approximately 50 percent more, before taxes, to meet its dividend obligations. Such a steep commitment will result once again in contractors being unable to generate sufficient revenues to cover their expenses. The proposal lacks guidance in defining an acceptable "market rate" for the founder's QFP when compared to an arbitrary benchmark rate. The proposal's benchmark rate by itself is inequitable because it fails to consider external and other business factors that influence a contractor's ability to pay an identical QFP rate. If the QFP is lower, the gift tax will be high, regardless of the firm's liquidity or its ability to approximate the benchmark rate. Contractors are dependent on a variety of factors beyond their control that affect their cash flow and thus their ability to pay a specified QFP rate. Construction projects can get delayed by weather and unforeseen soil and geologic conditions at the work site. Disputes over performance and payment often develop, which can delay revenues for years. There are a myriad of circumstances in the construction industry which can impact a firm's payment rate. Not the least of which are the size of the firm and its location. Construction in one region of the country may be stagnant while another is booming. Moreover, typically the industry has low earnings to assets ratios, which requires QFP rates to be set low for contractors to survive. If this provision survives Congressional scrutiny, it is critical that benchmark rates be flexible and that they be segmented by geographic region and industry classification. O The stipulation that the value of the junior equity interest equal at least 20 percent of the company's equity plus debt is unncessary. Valuation principles for preferred stock already examine the asset coverage ratio and the dividend coverage ratio of the preferred stock. Assigning such a percentage is arbitrary, too high a proportion and will require the parent to pay enormous gift tax penalities if future recapitalizations are required. Also, including debt as equity will impair the ability of firms to secure bank debt but who are currently relying on shareholders for equity financing. ABC recommends that there be no arbitrary floor value. Catching abusive recapitalizations is a laudatory public policy goal, but eliminating them is not the goal of this draft proposal. The Mr. Chairman, we again thank you and the committee for encouraging the healthy dialogue that has framed the debate on section 2036 (c). ABC believes that a workable, simple solution to abusive estate freezes and valuation problems can be crafted. replacement draft is a constructive first step in that process. It is essential, though, that we undertake this effort without delay. Small businesses everywhere are left vulnerable until such legislation is passed. ABC appreciates the opportunity to submit this testimony and looks forward to working with the committee on this issue. ## The Seattle Times F. A. BLETHEN PUBLISHER AND CHIEF EXECUTIVE OFFICER April 20, 1990 The Honorable Dan Rostenkowski Chairman Committee on Ways and Means U. S. House of Representatives Dear Mr. Chairman: The Seattle Times Company and Blethen Corporation would like to take this opportunity to express our views relating to the hearing to be held on a "discussion draft" to modify section 2036(c) of the Internal Revenue Code relating to estate valuation freezes on Tuesday, April 24, 1990. The "discussion draft" is an improvement over 2036(c). Unfortunately, it isn't much of an improvement. Section 2036 (c) is extremely bad legislation with very negative public policy implications. Much more needs to be done to correct the problems it created. The primary problem with 2036 (c) is that it represents an overly complex shotgun approach to try to cure a limited abuse which requires a rifle shot approach. While the "discussion draft" provides slight improvement, it is still overly broad, overly complex. It remains a shotgun approach to a rifle shot problem. The result is that the replacement legislation would continue to be anti-small and anti-private business and poor public policy for our local communities. What we need is replacement legislation which very narrowly addresses the limited legitimate abuses which have occurred. The very nature of 2036 (c) and potential replacement language is one which penalizes private and family businesses and which has a strong antibusiness tone. Replacement language should recognize that small and private businesses are extremely valuable resources to our overall economy and to our individual local communities. It should recognize that preserving and passing on these community assets is extremely difficult given family and shareholder dynamics, normal business risk and government regulation. |