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22.

23.

If considered, the payment stream, however contingent,
should be an amount that can be elected to be a QFP.
It should be made clear whether indebtedness includes
third party debt that is guaranteed by the transferor
or a member of the transferor's family. The significance
of this question is both for the interest in the entity
under Section 2703(e) (3) and for determining the minimum
20% junior equity. Section 2701(a)(3). The question
could be answered differently in both cases. Presumably,
if it is third party guaranteed debt, adequate interest
has been charged so that as a QFP it will be valued
equal to the funds loaned. However, if it had an equity
kicker such as a conversion feature or warrants this
would not be the case. In such situation, if the
principal was guaranteed, a transfer might be deemed to
occur. The consequence of failure to pay interest on a
guaranteed debt would usually be exempt under the
insolvency exception. If the guarantor paid interest
to the third party, the guarantor would be subrogated
to the rights of the third party and thus an indebtedness
would be created between the entity and the guarantor.
In the case of the minimum 20% junior equity requirement,
if guaranteed debt is included the inclusion of
transferor debt may in large part include all debt. As
in many small corporations all third party debt has to
be guaranteed. Such an interpretation greatly changes
the relationships and would be too severe a limit.
SUGGESTION: Indebtedness should not include guaranteed
debt until the guarantor has had to pay on the guarantee,
at which time, it is direct indebtedness.
Parent owns 60% of corporation and child 40%. Only one
class of common stock. The corporation is in need of
funds. Parent makes demand loan without interest to
corporation. Amount repaid two years later. Gift of
imputed interest is provided in Section 7872. (See
Proposed Regulation 1.7872-4(g)). However, since a
loan is a capital contribution that is an interest in
the entity it would result in a gift of the principal.
The actual payment would not be a QFP and thus not give
rise to a refund. SUGGESTION: Loans should not be
interests in an entity. If loans remain an interest,
they should be able to elect to be QFPs. Whether or
not elected, the repayment of principal should give
rise to a refund for prior gift.
Parent and child own stock in a corporation. Parent
receives deferred compensation agreement that provides
a life contingency: Presumably this is to be valued at
zero and is treated as an indebtedness which is an
interest in the entity. In some manner this would
effect value resulting in some gift. SUGGESTION:
Indebtedness should not be an interest in an entity.
If it is an interest in an entity, it should be limited
to indebtedness for money advanced.
Partnership is formed with parent contributing $1,000,000
and having the right to $100,000 each September 30th
provided the partnership has adequate cash flow to make
the payment and, if not, the amount will be accumulated
for payment later. Child owns an interest in the
partnership received in exchange for $300,000 which
receives all cash flow after all required payments are
made to parent. Although this is equivalent to a
preferred stock dividend it does not qualify as a QFP
as payment with respect to a partnership must be fixed

24.

25.

Exhibit C-2

as to time. $2701(b)(1)(A) (i). It presumably could be
an elected QFP. $2701(b) (4)(B)(ii). SUGGESTION: The
provisions for partnerships should be made parallel to
that of corporations. This interest should qualify as
a QFP. This could be accomplished by moving the language

in 52701(b) (4) (B)(ii) to $2701(b)(1)(A). 26. Grandparent owns preferred. Parent owns common. Parent

gives some common to child. Grandparent is incapaci-
tated. Statute requires that a guardian be appointed
for the purpose of making the election. Family may be
reluctant to go through the expense for this purpose or
the guardian may be unwilling to elect because it can
only be detrimental to the party electing. Parent
expects all payments to be made on preferred.
SUGGESTION: Permit transferor to elect for anyone
else who owns a QFP, if transferor is liable for any

subsequent gift tax.
27. The basic concept of the statute is to permit trans-

actions as long as they are properly valued and to
provide for a gift tax if the amount is not paid. The
structure of the statute deviates from the normal rule
of valuation of "willing buyer and willing seller" and
imposes an extremely harsh rule of valuation at zero if
one does not fit within certain defined provision of a
QFP. Since it applies to all transactions involving
family members it is doubtful that all of the possible
situations have been considered. SUGGESTION: Permit
any interest to be a QFP, if an election is made as to
the amounts to be paid. The revenue is adequately
protected. The taxpayer would then be protected in the
event there is interest no one has considered. It is
unlikely that there will be many of these situations
and they will impose a difficult burden. If there are
a lot it demonstrates that the statute is defective as
we have not thought of all the situations to which it
applies. At a minimum, permit the election in of any
partnership interest no matter what the nature of the

contingency, GRIT's and joint purchases.
28. Parent owns over 10% of common in publicly traded

corporation, as well as some publicly traded preferred.
Parent gives some common to child. Because corporation
has financial difficulty cumulative preferred dividend
is not paid. This would constitute a gift although
because of the public market there was no assumption as
to the value of the preferred in valuing the common and
the failure to pay the dividend on the preferred was
not tax motivated. SUGGESTION: Publicly traded

preferred should be exempted.
29. Corporation is not publicly held. Parent owns 40% of

preferred and 20% of common and gives 10% of common to
child. Corporation due to economic problems and
covenants in its bank loan agreement does not pay
preferred stock dividend. Since more than half the
dividends would be paid to nonfamily members, it is
clear the failure to pay dividends is not tax motivated.
SUGGESTION: The ownership level for the deemed gift
rule should be raised to at least 50% of the common.
Note that since the preferred must be cumulative the
only disadvantage to the government (advantage to the
taxpayer) is the time value of money issue.

Exhibit C-3

30.

31.

In the past, grandfather left common stock 50% to parent;
25% to child Å and 25% to child B. Child A has been
running the business and collecting a salary. Child B
wants income from corporation. Parent wants to become
less active in business. Corporation is recapitalized.
Parent and child B exchanges their common for cumulative
preferrred. Child B elects in. The corporation has
financial problems and does not pay the dividend.
Whereas imposing a gift tax on parent may be justified,
it is not justified to impose a gift on child B who
already has suffered the failure to receive dividend.
The concept of a freeze is to have the frozen interest
in the older generation. SUGGESTION: The transferor
for the deemed gift rule should only include individuals
in a generation older than the holders of common.
Buy-sell agreement was entered into between parent and
child with respect to their stock in a corporation they
owned. The price was to be determined by a formula
based upon an average of the last three years' earnings
times a multiple of 8. Earnings had normally
increased a little more than the inflation rate each
year.

The agreement was entered into 10 years prior to
death of parent and never looked at. An 8 multiple was
reasonable for the industry until the year prior to
death when the industry became very popular with the
stock market and a 12 multiple was more appropriate.
The child bought the stock from the parent's estate at
the buy-sell agreement amount and did not sell the
stock. Under the statute the buy-sell agreement will
not qualify and a higher value will be used in the
estate and yet if a review three years earlier occurred
it would have qualified. SUGGESTION: Impose no new
limits on buy-sell agreements. If this is not
satisfactory, the requirement of a review be eliminated.
If at any time during the period three years prior to
death the agreement was reasonably expected to produce
a price which would approximate the fair market value
of such property as of the time of such sale, the buy-
sell agreement should be considered in valuation.
Buy-sell agreement was entered into between parent and
child with respect to their stock in a corporation they
owned. The price was to be determined by a formula
based upon an average of the last three years' earnings
time a multiple of 8. Earnings had normally increased
a little more than the inflation rate each year. The
agreement was entered into 10 years prior to death of
parent. Two years prior to death the attorney who
drafted the agreement looked at the buy-sell agreement,
the appraisal used in determining the formula, and
comparable publicly traded corporations and concluded
it was adequate. An 8 multiple was reasonable for the
industry until the year prior to death when the industry
became very popular with the stock market and a 12
multiple was more appropriate. The child bought the
stock" from the parent's estate at the buy-sell agreement
amount and did not sell the stock. It is unclear what
formalities are required in such review. What if the
parent had reviewed it and determined it adequate; what
evidence must there be of such review? What if the
parent was incapacitated? SUGGESTION: Impose no new
limits on buy-sell agreements. If this is not satisfac-
tory, the requirement of a review should be eliminated.
If at any time during the period three years prior to
death the agreement was reasonably expected to produce
a price which would approximate the fair market value

Exhibit C-4

32.

33.

of such property as of the time of such sale, the buy-
sell agreement should be considered in valuation.
Buy-Sell Agreement was entered into between parent and
child with respect to their stock in a corporation they
owned. The price was to be determined by a formula
based upon an average of the last three years' earnings
times a multiple of 8. Earnings had normally increased
a little more than the inflation rate each year. The
agreement was entered into 10 years prior to death of
parent and never reviewed. Multiples in the industry
had moved to 12 four years prior to death. Buy-Sell
agreement provided for payments over 10 years with
interest. Buy-sell value of corporation was $2,000,000
the appraisal value was $3,000,000. Parent had an
estate plan leaving property all to spouse (had made
$600,000 of gifts to child during lifetime). Parent
had purchased two-life insurance to fund estate tax
liabilities paying off at the last to die of both
parents. Under this set of facts, the estate will be
$3,000,000 and the marital deduction only $2,000,000,
resulting in tax on $1,000,000 with no funds to pay.
Since the funds will reduce the amount going to the
marital deduction if the average rate iš 40%, it will
need to reduce the marital deduction another $666,000.

SUGGESTION: Impose no new limits on buy-sell agreements. 34. The buy-sell agreement between shareholders and the

corporations provides for a formula arriving at a
reasonable price except for the fact that it treats
insurance on the decedent as valued at cash surrender
value rather than face value. The agreement is reviewed
within three years of death and the purchase is made
pursuant to the agreement. This provision is typical
in arms-length agreements in order to avoid having to
purchase additional insurance in the corporation because
of the added value which the insurance provides.
SUGGESTION: Impose no new limits on buy-sell agreements.
If this is not satisfactory, include a provision similar
to "the price determined under an option (or agreement)
or formula shall not be considered to be less than fair
market value by reason of ignoring the difference
between the proceeds of a life insurance policy and
such policy's cash surrender value."

Exhibit C-5

33-144 0 - 90 - 4

STATEMENT OF E. JAMES GAMBLE, CHAIRMAN, ESTATE AND

GIFT TAX COMMITTEE, AMERICAN COLLEGE OF TRUST AND ESTATE COUNSEL, ACCOMPANIED BY WALLER H. HORSLEY, PRESIDENT, AND THOMAS P. SWEENEY, VICE PRESIDENT

Mr. GAMBLE. I am James Gamble, an attorney practicing in Detroit, MI.

I appear in my capacity as chairman of the Estate and Gift Tax Committee of the American College of Trust and Estate Counsel.

With me are Waller Horsley of Richmond, Virginia, president of the college and Thomas Sweeney of Wilmington, DE, who is vice president of the college.

We want to express our appreciation to the committee for the process you have provided us in making the discussion draft public and for permitting us to examine it, prepare comments and to submit the comments to you this morning.

The college supports the committee's effort to stop abusive valuation freezes. We support the approach used in the discussion draft in treating this as a gift tax valuation problem.

We wholeheartedly support the proposed repeal of section 2036(c) because we think that has been a disaster by and large and is bad legislation that should be repealed. We do feel that chapter 14 is too broad and complex. And we prefer the joint task force report that Mr. Wallace and Mr. McGaffey described to you because that would be simpler and less intrusive in the everyday affairs of small businesses than chapter 14.

I want to give you three examples of what we perceive to be some of the particularly complex areas raised by chapter 14. The first is that it applies to people who do not control the small businesses. Its threshold of 10 percent ownership is exceedingly low. People who own only 10 percent of a business are not in a position to engage in abusive freezes. They do not control the business. They also do on occasion, however, lend money to small corporations in which they own property. They also lease property to it, and this bill would impose upon them the burden of trying to de termine each time they want to make a gift of common stock to a member of their family whether or not they are subject to the provisions of this act.

It will require them to bring in a battery of lawyers and accountants to analyze it for them. It will be extremely costly. They may decide chapter 14 does or does not apply. It is just not worthwhile to make chapter 14 apply to people who are not the controlling forces behind the corporations.

Chapter 14 would also apply to people who own more than 10 percent of an interest in a publicly owned corporation. These people, again, do not control the course of the publicly owned corporation.

There seems to be no useful point in applying chapter 14 to them because they just are not in a position to install an abuse valuation freeze, which is what this is all about, in a publicly owned corporation.

Secondly, the discussion draft ignores the fact that market values may be readily available to be used for gift tax purposes.

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