Page images
PDF
EPUB

regulations and standards for rulings prior to enactment of legislation, and then if such regulations and standards appear practical the narrow problem of tax abuse can be met by enabling legislation.

TREATMENT OF ESTATES

A second major legislative proposal before the committee involves the treatment of estates.

The income tax rules as to estates are particularly important because most estates are small and therefore clarity and simplicity of rules are particularly important. Under the law prior to the 1954 code estates were generally taxed upon current income which was not properly paid or credited to an heir or benefiiciary. The 1954 code introduced a concept of “distributable net income and in effect provided a deduction for the estate and a tax upon heirs or legatees on distributions to the extent of the distributable net income. This has produced some unhappy results, particularly the taxation of heirs receiving corpus distributions who unexpectedly find themselves taxed as having received ordinary income.

The Advisory Group has recommended a change in the law which, in general, would return to prior concepts for a limited period by permitting the determination of whether a distribution is of income or corpus to be made in accordance with the accounts of the executor. Thus, in general, for a period of the first 36 months, if a bequest award or allowance is charged against corpus and designated as a distribution of corpus on the books and records of the estate by the fiduciary, it would be deemed to have been made from corpus.

I believe that the Advisory Group recommendation is sound in principle under the conduit approach because it is in accordance with the realities in the handling of most estates by informed fiduciaries.

However, I would like to see further consideration given to the possible use of an "entity” approach in the treatment of estates. The entity approach would recognize an estate in principle as a separate taxpayer and not just as a conduit. In effect it would result in the taxation of the estate as an extension of the existence of the decedent, although I doubt that it would be feasible to provide for joint returns, deductions for dependents, etc. The estate would be taxed on income received and there would be no tax to heirs or legatees on distributions from the estate.

The advantage of the entity approach lies primarily in its simplicity, particularly for small estates. The conduit approach, even under the Advisory Group's recommendations still contains some problems as to the treatment of gains, the nature of bequests, and the propriety of the records of the fiduciary.

The entity approach may result in greater tax in some cases, where the brackets of the beneficiaries may be less than that of the estate. This may be minimized by the early distributions of the income producing property. While this may create pressures for early distributions of property, such pressures may not be much different than pressures as to identification of distributions under the Advisory Group's recommendations.

One problem with the entity approach is that it would impose the tax on the fiduciary, and he may be liable even after distribution, if he did not properly determine and pay the full tax during the period of administration. This may be a serious problem in small estates where the executor is not well versed in tax matters but is saved now by distributing all the income, so that the liability falls on the heirs or legatees. This problem under the entity approach could be met at least in the last year of the estate by applying the conduit approach for such year, so that the heirs or legatees would be taxable on any income in the final year of distribution. Likewise provision should be made for carryover, to the distributees, of excess deductions for such final year, as under existing law.

I would suggest that the committee give consideration to permitting the fiduciary to elect to use the entity approach. This approach offers such possibilities for simplification that it should not be ignored.

I recognize that it may be said that the fiduciary will always elect to use the method that will produce the least tax. However, this is not necessarily the case, because the advantages of simplicity may in the final analysis prove less costly in administration than the complexities of the conduit method. Moreover, it is difficult to say what is the "right” tax an estate should pay as a matter of principle. Is the method that produces the most tax necessarily the proper method of taxing the income of an estate?

I believe that the entity approach is one of the few new ideas that has appeared and which offers possibilities for simplification in this important area of the tax law. The only way we can really tell how feasible it is is to try it; but at least until experience is gained, it should be an elective method, not mandatory.

There are many other phases of the treatment of estates and trusts that I have not touched on, but many of these will fall in place based on principles I have discussed. I believe the most important principle is that the law should be clear to the point at least that the Treasury Department can issue regulations and rulings that will provide administrative guidance and certainty for taxpayers.

I think we shall be facing a serious problem if the complexity of tax legislation grows to the point that the Treasury Department cannot issue clarifying regulations or advance rulings. I know no field in which it is more important that there should be administrative certainty, because estates and trusts involve fiduciary relationships and are mechanisms that serve a necessary purpose in our economy and society. I suggest that any further legislative proposals in this field be evaluated with these principles in mind.

INCOME OF ESTATES AND TRUSTS

James P. Johnson and Weston Vernon, Jr.

We understand that the subject we have been asked to consider is the general effect upon our income tax system of the present method of taxing trusts and decedents' estates, or more specifically, the extent to which this method may lead to an unwarranted reduction in the income taxes that should be paid by the beneficiaries of trusts and estates. We assume, therefore, that we are not to concern ourselves at this time primarily with technical problems. Our conclusion is that the present method of taxing trusts and estates is generally satisfactory, and that such changes as may seem desirable can be made fairly simply by a small number of technical adjustments, so that to this extent we will be dealing with technical aspects of the subject.

The basic principles of taxing trust and estate income under present law are, first, that income currently distributed or distributable by a trust or an estate is considered to pass through the trust or estate as a conduit, and is taxed to the beneficiaries as if the trust or estate had not intervened between the beneficiaries and the ultimate source of the income; and, second, that income which is not currently distributed or distributable, and which is accumulated by the trust or estate, is taxable to the trust or estate as if it were a separate individual taxpayer.

To the extent that the income of a trust or an estate is currently distributed or distributable, the existence of the trust or estate can have an adverse effect upon income tax revenue only to the extent that it may be considered to effect an unwarranted diversion of income from the income tax return of one individual taxpayer to that of another who is in lower tax brackets. To the extent that trust or estate income is accumulated, the trust or estate will itself become a new taxpayer to which the income may (or may not) be taxed at lower rates than if it were currently distributed to its ultimate recipient.

Before considering the different categories of factual situations to which these general principles could be relevant, we should examine the general picture as revealed by the Treasury Department's latest statistics of income. These statistics show that for 1956, which is the latest year for which figures are available, approximately 500,000 trusts and estates filed income tax returns. There were more than 360,000 trusts reporting total income of almost $4 billion. Taxable income retained by trusts was $660 million, or 16.6 percent of the total. On this income, trustees paid income taxes of $246,218,000. Out of the $660 million taxable income retained by trusts, only $117,553,000 represents income of trusts which had a taxable income of less than $10,000. The greatest opportunity for avoiding taxes through the use of trusts probably occurs where trusts accumulate

1 "Statistics of Income," 1956, U.S. Treasury Department, pp. 3-6.

a

income and have total income of less than $10,000. In the light of these statistics, the importance of the problem of tax avoidance, at least in accumulation trusts, may be greatly overestimated.

There seems to be current a distorted picture of the trust field from the viewpoint of tax avoidance. Published figures indicate that instead of being a "device” employed principally by those of great wealth for tax saving purposes, consisting of substantial sums, the average trust frequently consists of assets having a relatively nominal value. Data compiled by the Federal Reserve Bank of New York ? covering 162,000 trust accounts in 862 banks of the United States indicated that 43 percent of such accounts had principal value of less than $25,000.

Two other general observations should be kept in mind:

(1) Inter vivos trusts result from transfers of property, usually by way of gift, and frequently are subject to gift taxes; estates and testamentary trusts arise from involuntary transfers at death and are subject to estate taxes.

(2) It is unwise, in considering general problems relating to the possible unwarranted reduction in income taxes through transfers to trusts, to isolate such transfers from other forms of property dispositions. Many of the tax results of transfers in trust merely reflect the results which would follow from outright gifts of property, either of the entire interest, income for life, a term of years, or a remainder interest or other interest. So long as a system of law prevails which within varying limits permits a person to dispose of property by gift or by testamentary transfer, property interests will continue to be fragmentized into smaller units, and the income from the transferred portion may bear lower income taxes than if the transferor continued to hold the property. This is true in all areas of the tax law.

There has been criticism of the provisions of the tax law relating to trusts and estates on the ground of their asserted complexity. Simplicity is always a desirable objective if-and only if—it can be accomplished without multiplying undesirable doubts and uncertainties which are usually productive of disputes and delays in the determination and collection of taxes. Each proposal for simplification should be tested and carefully weighed in the light of the prior history in similar areas. Many taxpayers find the precision of present law, despite apparent complexities, preferable to vague provisions even if supplemented by regulations since the latter may or may not be valid interpretations of the law.

I. TAXATION OF TRUST INCOME TO THE GRANTORS OF INTER VIVOS TRUSTS

a

A. Trusts for the benefit of the grantor

If income of a trust is or may in the discretion of a nonadverse party be distributed to the grantor or accumulated for future distribution to the grantor, or if it is actually used to discharge the legal obligation of the grantor to support a dependent, the income will remain taxable to the grantor under section 677 of the 1954 code whether the grantor receives it or not. This section effectively prevents unwarranted diversion of the income tax burden in this type of trust.

9

. From a survey conducted under the auspices of the Trust Committee of the Com. mittee on Statistics of the American Bankers Association, "Trusts and Estates," August 1959, p. 736.

« PreviousContinue »