November 19, 1979
Page 33082
The PRESIDING OFFICER. The Senator from Virginia has the floor.
Mr. MUSKIE. Mr. President, will the Senator from Virginia yield for a moment?
Mr. HARRY F. BYRD, JR. I yield to the Senator from Maine.
Mr. MUSKIE. Mr. President, I have not been involved in the debate on the carryover basis issue. As one who voted to change the law in 1976, I am aware of some of the problems that have developed since that time with respect to the 1976 rules, problems having to do with the proof of basis, fiduciary responsibilities, and the complexity of computations, exemptions, and adjustments.
So I understand the concerns that have motivated this effort to repeal what we did in the 1976 law.
In all frankness, I have not reached a final position as to what a wise policy in this matter would be. I have had the benefit of a memorandum from my Budget Committee staff analyzing the problem, and I think it might be useful to other Senators, who do not have the benefit of such analysis, if I were to include it in the RECORD. So I ask unanimous consent to have this memorandum printed in the RECORD.
There being no objection, the memorandum was ordered to be printed in the RECORD, as follows:
MEMORANDUM
U.S. SENATE,
COMMITTEE ON THE BUDGET,
Washington, D.C.,
October 22, 1979.
Subject: Carryover basis.
SUMMARY
In 1976, Congress amended the Internal Revenue Code replacing stepped-up basis with carryover basis on assets transferred in estates. This meant that the base from which the taxable appreciation in the value of an inherited asset is calculated for the purpose of capital gains taxation was changed from the value at the time of inheritance to the acquisition cost of the decedent. This was seen as a major improvement in the equity of the tax system. Previously, much of the appreciation in various assets escaped capital gains taxation because of the stepped up basis provisions. The 1976 reforms are now scheduled to take effect December 31, 1979. The delay in implementation results from the complexity of the rules formulated for carryover. The Senate Finance Committee unanimously adopted an amendment to the Windfall Profit Tax bill, which strikes the 1976 reform. The Department of Treasury concedes that the 1976 provisions are very complex, but believes that the present law should be amended rather than starting over completely. The Treasury Department is supporting a bill introduced by Representative Fisher which would simplify the 1976 Tax Reform Act provisions.
Background
All forms of wealth are subject to capital gains tax, when the gain (loss) is realized. Therefore, a person purchasing a stock at ten dollars and selling that stock for twenty dollars incurs a tax liability on ten dollars of capital gain. This provision of tax law presents no difficulty. The controversy arises when an asset is transferred to one person from another, as a gift or bequest. It is commonly accepted that the appreciation of an asset transferred as a gift should not escape capital gains treatment.
Current tax law does subject that appreciation to taxation. There are two cases.
First, the asset may be transferred when the giver is still alive. In this case, the recipient assumes the giver's basis (the base value of the asset). If the stock had been purchased at $10, as in the previous example, and the recipient sold it for $20, he would be subject to capital gains taxation on $10. This is carryover basis; the recipient assumes the giver's basis.
Assets are also transferred as bequests through estates. Prior to 1978, these type of transfers were subject to a different determination of basis. All assets are assessed, when the estate taxes are paid. A recipient then assumed that assessed value as their basis. (This is stepped-up basis.) The appreciation of the asset that took place during the donor's life escapes capital gains taxation. The consequences of this rule can be seen in the following simple example.
[Table omitted]
A great deal of wealth escaped capital gains treatment because of the use of stepped-up basis. Treasury documented 4 cases in 1976 where appreciation exceeding $1.5 million escaped taxation.
Congress acted in 1976 to change this situation. The 1976 Tax Reform Act included a provision which applied the rules for carryover basis to bequests transferred at death. Two arguments were used in the support of the change. First, the stepped-up basis provisions were thought to distort capital markets. People were holding assets to death, rather than transfer them while alive, because of the tax treatment. Second, it was argued that the stepped-up basis violated the principle of horizontal tax equity. Two taxpayers, otherwise the same, were treated differently because of the condition of a donor of a gift.
The reform provisions adopted by Congress made all appreciation after December 31, 1976 subject to carryover basis. This implicitly required all wealth be assessed on that date. Rather than require such an undertaking, transition rules were developed to estimate the 1976 value, when an asset was transferred at death. These transition rules are very complex and have resulted in delay in the implementation of the reform. The following section discusses the problems in the current law.
PROBLEMS OF 1976 RULES
The carryover basis provisions scheduled to take effect December 31, 1979 are expected to be burdensome in several respects. First, the liquidity problems of certain estates will be increased. Second, a series of administrative problems are created for executors of estates. Third, the provisions require a complex set of computations, exemptions and adjustments complicating the estate tax system.
1. Liquidity.
Inheritors of estates which are illiquid may have to sell assets to pay estate taxes. Under carryover provisions, the sale of these assets creates an income tax liability, which may in turn require the sale of additional assets. This may cause serious problems in estates with closely held corporations: sales may be difficult and result in capital losses.
2. Administrative Problems.
a. Proof of Basis.
Carryover requires knowledge of the decedent's basis for all properties, that is the price or value of the asset when acquired. The new basis equals the value at death minus the growth in value since 1976. The recipient's basis is based on an assumption that the value of an asset appreciated constantly between the decendant's acquisition value and 1976. Opponents argue that the administrative difficulty caused by this requirement makes carryover unworkable. It is argued that proof of basis can be a problem for any property, but is most likely to affect intangibles, personal and household effects and residences (for which gains in value are primarily caused by improvements made during the life of the decedent). Most people do not keep sufficient records to support the basis of these assets. Furthermore, the basis as reported at the time of the disposition of the estate is not accepted in law. The IRS may contest that basis when the asset is disposed of by the beneficiary. (This is the so-called "suspended basis" problem.)
b. Fiduciary Responsibilities.
An executor has a fiduciary responsibility to treat beneficiaries fairly. Currently, executors must make decisions on which assets should be sold to pay estate and gift taxes. This requires considering yield and growth potential. Carryover creates a need to consider another set of factors: first, the consequences of selling high basis versus low basis properties and second, the distribution of assets with various bases to benefit all recipients. This requires knowledge of the various recipients' income tax position. Some argue that failure to take these factors into account may result in the executor being subject to a surcharge on his commission.
3. Complexity of Computations, Exemptions and Adjustments.
a. Cost Basis.
An estate may possess similar assets received at different times, for example, stock in a corporation in which some shares were purchased and others received as dividends. It is not difficult to ascertain the purchase price of that stock; however, the appreciation in value must be computed several times recognizing different acquisition dates. While in this example, that is not difficult, it does increase the number of calculations to be completed. The problems increase for assets with a market value not easily available as marketable securities. Shares in a closely held corporation are seen as causing great difficulty.
b. Personal and Household Effects Exemption.
The 1976 provision contain an exemption of $10,000 for household and personal effects. Any assets may be included in that exemption, up to a total market value of $10,000. Opponents foresee this exemption causing problems. Primarily, these problems arise when it is necessary to ascertain cost or assign an allocable portion of the exemption to a set or collection, for example, allocation of original cost or a remaining exemption amount to a set of silverware purchased and valued for estate tax purposes as a collection where the individual units may have varying costs and values.
c. Fresh-Start Adjustments.
The 1976 reform subjected the appreciation of an asset since 1977 to the carryover provision. This implicitly requires a January 1 valuation of all assets on that date. Several interim rules were developed, rather than subject all assets to an actual valuation. For marketable securities the listed value for the January 1, 1977 date is used, but only for the purposes of a capital gain. For non-marketable securities historical cost and market value at the time of death must be known. The asset is then assumed to have increased in value evenly over that time period — the December 31, 1976 value then equals the average annual increase multiplied by the number of years since 1976. Unfortunately, historical cost is not always known and assuming constant value increases may create inequities. Third, for other properties the 1976 value is determined
by discounting the market value at time of death by 8 percent annually to 1976. This combination of adjustments and rules increases the burden on the executor and the costs of settling an estate.
d. Death Tax Adjustments.
All properties subject to death taxes are adjusted in value to reflect that cost. (A payment of taxes reduces the assets' value.) The tax consequences of selling a particular asset is not known until the marital and charitable deduction are taken. The uncertainty in settling an estate is increased.
Second, the "suspended basis" of assets causes a problem until an IRS audit is completed. It is argued that the death tax adjustment may have to be recalculated for every carryover basis item if a single audit change results in a higher or lower estate tax. The provisions now require that adjustment be made by calculating the marginal tax rate applicable to each carryover asset. Because up to three estate taxes may apply to an asset, this calculation may have to be done three times.
FISHER AMENDMENT CHANGES
Representative Fisher of Virginia has introduced an amendment to correct some of the complexity of the 1976 provisions. The Administration supports the Fisher amendment as introduced. The major provisions of the Fisher amendment are:
1. The minimum estate size is increased from $60,000 to $175,000. This excludes 98 percent of all estates from carryover;
2. All estates, subject to the law, are provided a minimum basis of $175,000. This basis can be allocated to any assets reducing the liquidity problems; the basis can be applied to assets being sold to meet death taxes and therefore reducing the total income tax liability;
3. The death tax adjustment is simplified with one calculation replacing the three separate, but interdependent, calculations now made. A single tax rate is applied to all appreciated property in the estate — the highest marginal tax rate the estate is subject to — before any credits are applied. This approach reduces the problems created by audits challenging valuations of particular assets changing the applicable tax rates;
4. The liquidity issue is further addressed by allowing closely held businesses to qualify for the deferred estate tax privilege, at the executors' discretion;
5. Similar assets, acquired at different times, no longer would have to be valued separately. An executor can elect to compute an average basis for all of these assets;
6. The bill increases the tangible personal property exemption from $10,000 to $25,000;
7. The fresh start provisions are simplified. First, the fresh start adjustment applies to both gains and losses. Second, the adjustment applies to both gains and losses. Second, the reported value of marketable securities is utilized to establish the value of these assets. Third, the December 31, 1976 value of all other assets is determined by discounting the value at death by 6 percent annually.
8. A procedure is created which avoids the problems caused by suspended basis. The IRS is required to accept the estate tax basis established by the estate tax return.
Mr. MUSKIE. Mr. President, between now and the time that the vote will occur, I will decide how I should vote. However, I hope that in due course, probably in connection with the debate on the windfall profit tax, we may have an opportunity to explore this issue more thoroughly and to understand some of the options that may be available to us, and that a later vote may be more conclusive — at least, as to my final judgment on the issue — than the vote that is taken today.
I applaud the distinguished Senator from Virginia for raising the issue and creating the opportunity to discuss some of these problems. I thank the Senator for yielding to me at this time.
Mr. HARRY F. BYRD, JR. I thank the Senator from Maine.
This is a very complex issue. That is why it occurs to the Senator from Virginia — and many others, for that matter — that what needs to be done, regardless of how one feels about the merits or demerits of the carryover basis provision, is to get the present law off the statute books. I can assure the Senator that virtually every witness says it is not workable. Estate executors and all those involved in the handling of estates, say that the law cannot be complied with. The Treasury Department, which is a strong advocate of the carryover basis provision, says that it cannot even be administered. So we have a law on the books which is totally unworkable.
It seems to me that the logical thing to do is to repeal this law. Then, those who have proposals to put in its place can present those proposals next January, in the form of a bill.
As chairman of the Subcommittee on Taxation, I will hold hearings on that bill or those bills, as the case may be. I will be glad to set any date in March — with the exception of March 17 — which would be most convenient to those who are interested in this matter. I will hold hearings on it and then decide what is the best course of action to follow.
If we do not repeal this matter now, the deferral of carryover basis which Congress found necessary to enact last year will expire on December 31 of this year and at that point, an unworkable law will come back on the statute books.
Mr. MUSKIE. I am under the impression that the Senator is right, that the present law is unworkable, that it would be impossible to administer, and there seems to be little doubt about that. I want the Senator to understand that I share that judgment, on the basis of a considerably lesser understanding of the issues than the Senator has.
However, there are two approaches to dealing with the problems created by the 1976 Tax Reform Act. One is legislative, and I have been interested in the so-called Fisher amendment in the House, which proposes some corrective legislation. That is one approach; whether or not it will be offered on the floor of the Senate, I have no idea.
The other approach has to do with what the Senator has suggested. So I understand what he is saying and what he is proposing. His willingness to come to grips with the issue is commendable, so far as I am concerned. The law needs to be changed; I have no doubt about that.
So I hope the Senator will understand that our positions really are not that far apart. Where we may come out in the end, when the issue has been explored thoroughly and alternative legislative approaches have been examined, I do not know. We may come out in different positions at that time. We start from a common understanding that the present law is unworkable and needs to be changed.
Mr. HARRY F. BYRD, JR. I thank the Senator from Maine. I think that is a very reasonable approach.
The Senator mentioned the Fisher proposal. I know Representative FISHER. He is from my State. He is a fine man. No hearings have been held on his proposal in the Senate. The Subcommittee on Taxation of the Senate Finance Committee has held no hearings on it.
Not even one bill has been introduced this year in Congress to do anything with carryover basis except repeal it.
I hope that we will not try to legislate, on the floor of the Senate, a complicated and complex part of the tax code without hearings, without giving the public an opportunity to express their views.
Twenty-five or 30 or more organizations are vitally interested in this matter. I have put their names in the RECORD. It seems to me that they should have some opportunity to have some input before we rewrite the tax code in this respect.
That is why I suggest that the most logical way to proceed, it seems to me, is to hold hearings on this measure. I will hold them any day or days — 2 days, 3 days, 1 day, 5 days, whatever is necessary — except March 17. I will hold a hearing on any date that is preferred by the Senator from Maine or any others who are interested in this matter.
Mr. MUSKIE. I appreciate that attitude on the part of the distinguished Senator from Virginia,
which I would expect in any case.
If what we are being offered on the floor, or what may possibly be offered on the floor, fell into the jurisdiction of any committee which I chair and had similar complexity, I expect that I would take the same attitude the Senator from Virginia takes. It is not an unreasonable attitude at all.
Mr. HARRY F. BYRD, JR. I am sure the Senator from Maine would take that attitude, not because he was a member of a particular committee, but because of the public concern.
I have a letter from the American Bankers Association dated September 7, 1979. They submit a 65-page analysis of the extensive policy and technical problems involved with the fiduciary legislation. This is just one group.
Mr. MUSKIE. Would the Senator put that analysis in the RECORD at this point? It might be helpful, since my amendment described some of the approaches of the Fisher amendment. That analysis might be useful to those who wish to read the RECORD.
Mr. HARRY F. BYRD, JR. I will be glad to do so.