The whole purpose of section 2701 is to provide a mechanism for determining the value of common stock that is given away. When that common stock is in a publicly traded corporation, there is no necessity to go through this process. Yet, under the bill, you would have to go through the special rules, come up with a value that probably would be different than that for which people are buying and selling the stock on an everyday basis and use that for gift tax purposes. It makes no sense whatsoever to do that. There is another area in which a fair price is readily available, but the statute would not recognize the availability of it nor sanction its use. That is in the context of a sale by the principal owner of the common stock he owns to a management team who will succeed him, most of whom are people who are not members of his family, but that does include one or two members of his family. He may negotiate at arms length for days and weeks to come up with a fair price, then sell the common stock to the management team. It will be treated like an arm's-length transaction insofar as those people who are not family members are concerned, but selling it for the same price to his own children will cause him to be in a situation in which he may have to pay a gift tax. There is no rhyme nor reason to that kind of arrangement. My last example involves what I refer to as the adoption by gift rule. The statute provides, for example, that if you are the principal owner of a corporation and your sales manager decides to get married and you buy him a wedding present, your sales manager becomes a member of your family. Why is that? We are unable to determine why that rule is in the discussion draft. But if the sales manager along with other unrelated employees is receiving stock bonuses or is under a program in which he can buy stock from the corporation from time to time, he will be treated as a member of the principal owner's family and possibly subject the principal owner to a gift tax because the sales manager buys or receives stock from the corporation in what is otherwise a routine transaction. That ends the examples I want to put before you. There are many more in our written statement. We appreciate very much having the opportunity to appear before you today. Thank you. [The statement of Mr. Gamble follows:] STATEMENT OF E. JAMES GAMBLE ON BEHALF OF THE AMERICAN COLLEGE OF TRUST AND ESTATE COUNSEL BEFORE THE COMMITTEE ON WAYS AND MEANS Mr. Chairman and Members of the Committee: My name is E. James Gamble, and I am a tax and estate planning lawyer who practices in Detroit, Michigan. I am pleased to be here today on behalf of the American College of Trust and Estate Counsel with my colleagues, Waller H. Horsley and Thomas P. Sweeney, who are, respectively, the President and Vice-President of the College. I represent the College in my capacity as the Chairman of its Estate and Gift Tax Committee and of its Section 2036(c) Task Force. The membership of the College is composed of more than 2600 lawyers who specialize in the practice of trust and estate law and related tax matters. A major and continuing effort of the College since it was organized over 40 years ago has been the improvement and reform of probate and transfer tax laws with the ultimate goal of simplifying the disposition of property and the administration of estates in this country. The College is grateful for the opportunity to appear before this distinguished Committee to express its views concerning the repeal of Section 2036(c) and the Discussion Draft containing the proposed new Chapter 14. We welcome and accept once again the challenge of working with the Congress to find additional ways to improve and simplify the nation's transfer tax laws. THE COLLEGE SUPPORTS THE COMMITTEE'S GOAL TO ELIMINATE ABUSIVE VALUATION FREEZES. Committee's concerns about The College shares the taxpayers who avoid the Federal estate and gift tax laws through the use of abusive valuation freezes, and we support the Committee's objective to eliminate abusive freezes, but the College has been deeply concerned about the complexity and breadth of Section 2036(c). The College feels that section 2036(c) has many flaws, the worst of which it has described in "Section 2036(c)'s Little Chamber of Horrors," which is attached as Appendix A. The College enthusiastically supports the Committee's proposal in the Discussion Draft to repeal Section 2036 (c) retroactively. The College agrees with the Committee that the abusive freeze problem is really a valuation problem, and we believe the Discussion Draft correctly treats abusive freezes as a gift tax valuation matter. We would much prefer to have the Committee adopt the approach set forth in the report of the Joint Section 2036(c) Task Force that is attached as Exhibit A to the testimony of Jere D. McGaffey because we think that proposal will produce a more narrow and simple solution to the problem without any loss of revenue. Nevertheless, we are pleased to have the opportunity to offer our comments on the Discussion Draft. The College feels the scope of Chapter 14 is broader and more complex than is necessary to solve the valuation problem, and as a result it would unnecessarily intrude in many routine business transactions without thereby solving the abusive valuation freeze problem. We believe that Chapter 14 can be narrowed and simplified without diminishing its effectiveness in eliminating abusive freezes and without losing any revenue; and that the adoption of our suggestions would reduce the time and cost that taxpayers, their advisors, and Internal Revenue Service personnel will have to spend to understand and administer the law, and would thereby increase compliance with the law. THE SPECIAL VALUATION RULES IN SECTION 2701 ARE BROADER THAN NECESSARY TO ELIMINATE ABUSIVE VALUATION FREEZES. 1. Chapter 14 should not apply to businesses that are not controlled by the transferor's family. The person who creates an abusive freeze does so because he believes he can cleverly shift a major part of the future appreciation in the business into the common stock that he plans to give away. Believing this, he is not about to share the benefits of such a value shift with nonfamily members who also own common stock. For this reason, virtually all of these transactions occur in businesses that are owned solely by the members of one family. As a result, we feel it is unnecessary to apply the special valuation rules to entities of which a family may own as little as 10 percent. The 10 percent test should be increased to more than 50 percent. If the Committee is concerned about a business that is owned by several families who might act in unison in a recapitalization (a situation we believe is rarely encountered), Chapter 14 should apply only to the members of those families whose combined ownership would exceed 50% of the corporation or partnership. 2. Section 2701 should not apply to equity interests for which a fair market value is readily available. The special valuation rules in Section 2701 prescribe how a preferred interest in a corporation or partnership must be valued in order to determine a value for a nonpreferred equity interest in a corporation or a partnership that is transferred to a member of the family. However, there are several situations in which market values are already available and in these cases using the special valuation rules would be unnecessary and would produce an incorrect and unfair result. or the common (a) Publicly traded securities. When either the preferred stock stock is publicly-traded, special valuation rules are not needed because market values are readily available and should be used. (b) Negotiated sales prices. If a person who owns preferred stock decides to sell his common stock to a group of buyers composed of both unrelated persons and family members; and if a substantial portion of the stock is sold to the unrelated persons for a price that is negotiated at arm's length, the special rules in Section 2701 should not apply to the stock sold to a family member for the same price. If the special valuation rules are applied in this case, the seller would be liable for a gift tax on the stock that he sold to his family members at the same arm's-length price he negotiated with the unrelated persons, and in order to avoid a patently unfair gift tax in this situation he must eliminate the family members from the purchasing group and sell only to unrelated persons. Today, this may well mean a sale to an entity that is not owned by Ū. S. citizens, with the result that the value of the business (and its future growth) will disappear entirely from our transfer tax system. This adverse tax result is also one of the defects in Section 2036(c), and is described in "Section 2036(c)'s Little Chamber Horrors" (Appendix A). It should be eliminated. of (c) Sales to ESOPs. The sale or contribution of stock to an employee stock ownership plan (ESOP) is closely regulated and subject to Department of Labor rules that set forth requirements for determining the fair market value of stock acquired by a qualified plan. If shares in the same class of stock are sold to family members as an integral part of an ESOP transaction, the transferor should be permitted to use the value determined for ESOP purposes rather than having to use the special valuation rules. 3. Indebtedness and leases should not be "interests" to which Section 2701 may apply. It is not clear to us how an abusive valuation freeze of an equity interest in a corporation or a partnership can be accomplished by using indebtedness or leases. It is difficult to identify a fact situation in which the existence of debt owed to the transferor or a member of his family, or a lease of property by the transferor to the entity, could cause the value of a corporation's common stock or of a partnership's equity to be diminished for gift tax purposes. If it were possible to diminish nonpreferred equity values through these devices, we believe it would simply increase the value of the transferor's right to receive payments under the indebtedness or the land subject to the lease. If the provision regarding indebtedness is in the Discussion Draft to deal with so-called "self-cancelling installment notes" (SCINS), we recommend that a specific provision be placed in the statute to deal just with this kind of obligation. Including indebtedness and leases in Chapter 14 increases unnecessarily the scope, complexity and intrusiveness of section 2701 because it is so common for one or more owners of a business to lend money or to lease property to the business. This provision will make it much more difficult for the business owner who owns no preferred equity in the entity (and his advisors) to determine when and how the special rules in Section 2701 might apply. 4. An unrelated person should not be considered a member of the transferor's family just because the transferor has made a prior gift to that person. Section 2703(a)(2) provides that if a transferor has made a gift of any kind to someone who is not a member of his family, that person automatically becomes a member of his family for purposes of Chapter 14, apparently forever. Under this rule, if any employee of a corporation who has received stock through a bonus or stock purchase plan is married and receives a wedding gift from the corporation's principal owner, the donee becomes a member of the principal owner's family. The common stock the employee owns would be attributed to the principal owner of the corporation, and any subsequent stock that is awarded to, purchased by, the employee may become subject to the special valuation rules of Section 2701, thereby exposing the principal owner to all of the valuation and gift tax consequences of Chapter 14. This "adoption by gift" provision makes it necessary for a business owner and his advisors to search the owner's history for the names of all of the persons to whom the owner has ever made a gift, no matter how small and no matter of what kind or nature, in order to determine if and to what extent Chapter 14 may apply to a transfer of stock. We fail to understand how this rule will prevent an abusive valuation freeze. Its usefulness in the general scheme of Chapter 14 is tenuous that there is no way to justify the extraordinary or complexity it will add to the administration of Chapter 14. CHAPTER 14 IS MORE COMPLEX AND INTRUSIVE THAN IS NECESSARY TO ACCOMPLISH ITS OBJECTIVE TO ELIMINATE ABUSIVE VALUATION FREEZES. 1. Much of Chapter 14's complexity comes from its scope. The provisions described in the preceding paragraphs (the 10% rule, the failure to permit use of readily available market values, the inclusion of indebtedness and leases, the "adoption by gift" rule), increase the scope of Chapter 14 unnecessarily and thereby increase unnecessarily the complexity of the statute and its intrusion into routine transactions that in no way relate to abusive valuation freezes. 2. Trust transactions should be placed in a section separate from the section that applies to corporations and partnerships. The College understands that the purpose of the trust provisions in Chapter 14 is to deal primarily with grantor retained interest trusts, joint purchases, and private annuities. However, the trust provisions are inserted as exceptions to the rules that apply to corporations and partnerships, which makes it very difficult to sort out the provisions that apply to trusts. We believe it is possible to segregate the provisions that deal with trusts in a separate section and to sharpen the focus of these provisions so that they apply clearly to the perceived abuses at which they are directed. Making these changes would considerably simplify the statute and increase the ability of taxpayers and their advisors to understand and to comply with these rules. GRANTOR RETAINED INTEREST TRUSTS (GRITS) SHOULD BE GOVERNED BY THE STATUTORY PROVISIONS ENACTED IN 1988. GRITS have received much attention from the Committee and its staff. After extensive study in 1988, the Committee placed special rules for a so-called "statutory GRIT" in Section 2036(c)(6), and we believe the Committee considered those provisions satisfactory to control the use of GRITS. The College has no information on the number of statutory GRITS that have been adopted since they were specifically authorized, but we submit there is no good policy reason to reverse the decision made Moreover, the Discussion Draft does not indicate what effect the new rules will have on GRITs that have been adopted in reliance on existing law. in 1988 and now adopt still another rule. NO PROVISION IS NEEDED FOR OPTIONS, BUY-SELL AGREEMENTS AND RIGHTS OF FIRST REFUSAL. Section 2702 changes significantly the present law that applies to provisions now commonly found in buy-sell agreements. These agreements are not typically undertaken for estate planning purposes, nor are they used to achieve abusive valuation freezes. They are So routinely used by business owners, and the concepts used in them are So commonly understood, that it is not unusual for small corporations and partnerships to enter into buy-sell agreements without even consulting their legal counsel. The usual business purposes of these agreements are to assure a continuation of the business upon the death or withdrawal of one of the owners; to provide market for the equity interest of the owner who dies or wishes to withdraw by specifying the price and terms on which that interest will be purchased by the person who continues to operate the business; and to prevent the transfer of an interest to a person who might not be acceptable to the continuing owner as a compatible and competent participant in the business. There is now a substantial body of law governing |