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Mr. Chairman, I want to thank you for this opportunity to appear before the Ways and Means Committee and tell you what I think is wrong. Frankly, however, I must say I will be trying to pass my bill, S. 659, and protect families who achieve every American's dream and really create a new business to pass on to the kids.
Chairman ROSTENKOWSKI. Thank you, Senator, for sharing these thoughts with us.
Any questions of Senator Symms?
Senator SYMMS. Thank you.
Chairman ROSTENKOWSKI. Mr. McGaffey, Mr. Wallace, Mr. Gamble, and Mr. Hoffman.
STATEMENT OF JOHN A. WALLACE, DIRECTOR, PROBATE AND
TRUST DIVISION, AMERICAN BAR ASSOCIATION, SECTION OF REAL PROPERTY, PROBATE AND TRUST LAW, AND PARTNER, KING & SPALDING, ATLANTA, GA
Mr. WALLACE. I am John Wallace, a practicing attorney in Atlanta, GA, representing the real property, probate and trust law section, and with my colleague Mr. McGaffey, representing the tax section, giving the views of the American Bar Association. Mr. James Gamble, with the American College of Trust and Estate Counsel is also on our panel.
We have formed a task force to consider section 2036(c) and what should be done with it. We are here as a panel as a result of that initiative. Mr. Hoffman's group, the American Institute of C.P.A.'s has consulted with us on our efforts.
First, we would like to praise the process that has preceded these hearings. Our conversations in private with staff, followed by their presentation of the discussion draft, circulation of that draft, further discussion on that draft after circulation and now these hearings, represents a refreshing change.
We stand for the proposition that section 2036(c) is unworkable, and should be repealed.
We agree as well that valuation problems exist in the so-called estate freeze area. In the estate tax system difficult to value assets are valued by assuming a negotiating process between a hypothetical willing buyer and a willing seller who are unrelated to each other. The typically constructed estate freeze in a family corporate recapitalization context, however, runs contra to that assumption because the parties are usually related to each other and the arm's-length dealing that is assumed in the hypothetical valuation standard typically does not exist.
Often taxpayers valued the preferred stock in recapitalizations by assuming that voting rights, conversion rights, put rights and other discretionary features bolstered the value of the preferred stock sufficiently to make it equal to the common stock that was exchanged in the recapitalization. Everyone knows it was unlikely, given the estate plan being implemented, that the holder of the preferred stock would exercise those rights in his or her economic self interest, hence, the problem. So, we agree that a problem exists.
We think it exists with respect to these discretionary rights attached to preferred equity interests, typically called bells and whistles that were never intended to be rung or blown.
We have developed a proposal, which we have discussed with Treasury and the staffs of the tax-writing committees in Congress, devaluing those discretionary rights. We submit that our proposal, which represents a departure from the hypothetical willing buyer/ willing seller standard, is properly cast as a narrow departure from that standard because that standard has worked well in the rest of the estate and gift tax area over many, many years. As such, it represents a system that should be left in place with minor adjustments.
Chapter 14, the discussion draft that is before you, takes an oppo site approach by declaring which rights and interests will have value and then stating that everything else will have no value. We take the view that the rules should designate the rights and interests which will have no value and declare that everything else has value. We are really looking at this problem from opposite ends of the telescope, if you will. We think our approach is better because it, frankly, puts the burden of uncertainty, that is the question of what is going to be deemed to have no value on the Treasury, and not the taxpayer.
Our proposal tells practitioners in this country what they cannot do; it allows existing rules, which are fairly well known, what they can do. It is a question of whether the glass is half empty or half full, that is, should you state what is wrong and declare everything else is right or should you state what is right and declare everything else is wrong?
Frankly, we think our approach, which may be more modest than the approach taken by the discussion draft, is the right one because if it doesn't solve all the problems that bring us here today, it is easier for you to enact legislation than it is for us to seek the repeal of the overbroad statute.
So, we would rather start in an orderly way at the beginning of the process and leave to future experience the question of whether to adjust the rules that are enacted in response to the estate freeze problem.
We have some specific concerns, Mr. Chairman, about chapter 14 beyond our elemental disagreement as to the approach that is taken to modify the hypothetical willing buyer/willing seller valuation standard.
Those specific concerns relate to the discussion draft's treatment of buy-sell agreements, which have been very useful tools for family planning in this area and which may be jeopardized under the requirements in chapter 14.
We also have concerns about chapter 14's treatment of options, leases, and other rather standard nonequity type arrangements that crop up all the time in family business settings.
In short, we applaud the process that has occurred. We agree that there
is a valuation problem here that needs to be solved. We have a different approach for serving that problem that we have been discussing with the Treasury and your staffs prior to these hearings, and we represent to you that we will continue that discussion process.
Now I would like to turn our commentary over to Mr. McGaffey for more specific comments on the chapter 14 proposal that you have before you this morning, Mr. Chairman.
[The statement of Mr. Wallace follows:]
Concerning Chairman Rostenkowski's discussion draft of a bill to modify section 2036(C) of the Internal Revenue Code of 1986, as amended, relating to estate valuation freezes
April 24, 1990
Mr. Chairman and Members of the Committee:
I am John A. Wallace, Division Director of the Probate and Trust Division of the Section of Real Property, Probate and Trust Law of the American Bar Association (the "ABA"). I have been designated to testify, along with Jere McGaffey, the Chair Elect of the Section of Taxation, on behalf of the ABA at these hearings.
First and foremost, we applaud the process that has preceded these hearings on Chairman Rostenkowski's discussion draft relating to estate tax valuation freezes. Having the opportunity to review in advance a draft of proposed legislation, meet with staff members to discuss the draft, and present testimony to this Committee before final decisions are made, are a vital part of a stable transfer tax system.
The ABA in August of 1988 adopted resolutions calling for the repeal of section 2036(C) and pleading for stability in the Federal transfer tax system. Those resolutions state the official policy of the ABA today.
In the press release announcing this hearing Chairman Rostenkowski referred to the "legitimate complaints" about section 2036(C), while indicating that a re acement is needed to "preserve the integrity of the Federal estate and gift tax system. We believe that the repeal of section 2036 (C) is necessary to preserve that systemic integrity. Further, with all due respect and admiration for those who have worked diligently to develop Chairman Rostenkowski's discussion draft, we believe that it shares with section 2036(C) enough of the same flaws (including extraordinary complexity, ambiguity, overbreadth and inadministrability) to continue the present threat to the integrity of our transfer tax laws. That it may represent some improvement over section 2036(C) is not enough to warrant enactment in its present form.
REPEAL OF SECTION 2036 (c)
Planning for the disposition of interests in closely held businesses and farms is often essential to the survival of such enterprises. Given the importance to this country of private enterprise and the orderly transmission of private property, the Federal system of taxing the transfer of such property must be understandable, stable, reasonably administrable and perceived as essentially equitable.
Section 2036(C), by virtue of its breadth, complexity and inability to be consistently administered, has made planning for the disposition of such property virtually impossible. In addition, because it treats family members doing business together more harshly than unrelated business partners, it is perceived as inequitable. As a result it has posed a serious threat to the preservation of family businesses and family farms and generated great instability in the Federal transfer tax system.
The American system of voluntary compliance depends upon taxpayer confidence in the fairness and stability of our tax laws. For this reason, and for those set forth below, section 2036(C) should be repealed and replaced only with a statute that is understandable, narrowly focused, and capable of being efficiently and evenly administered. Introduction and Background:
Section 2036(C) was added to the Internal Revenue Code by the Revenue Act of 1987 and substantially modified in the Technical and Miscellaneous Revenue Act of 1988 ( "TAMRA"). It is a transfer tax (i.e., estate, gift and generation-skipping transfer tax) provision that appears to have been aimed initially at halting a business owner's perceived ability to transfer a disproportionate right to future appreciation in the value of a