August 28, 2017 - Weekly Legislative Update

On the Regulatory Front

 

As things continue to be quiet on the Hill with both chambers out on recess, we wanted to take this opportunity to let you know about some of the work that TIA has been doing on the regulatory side of things.

As we previously reported, on April 21, 2017, President Trump issued Executive Order 13789. Designed to reduce burdensome tax regulations, the Order instructed Treasury to review all significant tax regulations issued since 2016, and take action to alleviate the burdens of those regulations that (i) impose an undue financial burden on U.S. taxpayers; (ii) add undue complexity to the federal tax laws; or (iii) exceed the statutory authority of IRS.

In response to the President's Order, the Treasury identified eight sets of regulations for review and asked the public to comment on how these regulations should be fixed.  (It's hard to believe there are only eight sets of IRS regulations that fit the criteria of the Order!)  Pursuant to the requests of TIA and many other groups, IRS identified the proposed regulations under Section 2704(b) of the Internal Revenue Code for consideration.  Section 2704(b) applies only to family-owned businesses. The proposed regulations would eliminate minority discounts, and largely eliminate marketability discounts, thereby making it harder and far more costly for the older generation to gift interests in a family-owned business to the younger generation

TIA has opposed these regulations since their initial introduction on the basis that it is fundamentally unfair to single out family-owned small businesses for worse treatment under the tax laws than non-family-owned businesses.  TIA believes that the proposed regulations should simply be withdrawn and not replaced and offered its comments to IRS, some of which are summarized here.

One of the biggest concerns that TIA raised is that the reality of what it takes to run a successful, active family-owned business is not understood by Treasury and IRS. Experts who advise active family-owned businesses know that the issues that arise among family members are similar to, and sometimes worse than, those faced by non-related owners of a closely held business. Treasury and IRS believe that any dealings amongst family members in a family-owned business are not arms-length - in fact, they have conjured up an image of a family where all family members are in lockstep with each other so that they basically operate as a single person with a single voice.  

They clearly have not seen many family-owned businesses in operation!  Family-owned businesses play an integral role in the small business engine that fuels growth and provides jobs in this country.  Therefore, though it is often difficult, it is critically important that these family-owned businesses successfully transition to the next generation. Many of your members are family-owned businesses, and many have existed for more than one generation. If the proposed regulations are allowed to go into effect in their current form, not only will it be costly for family-owned businesses, but it will make it even more difficult to successfully transition the business to the next generation.

The proposed Section 2704(b) regulations provide that certain non-commercial restrictions on the ability to transition family-owned business to the next generation should be disregarded in determining the fair market value of an interest in that business. Initial comments on the proposed regulations, including those of TIA, expressed concern that the proposed regulations would eliminate or restrict minority discounts and discounts for lack of marketability, which would result in increased valuations and taxes that would increase financial burdens for family owned businesses.

Importantly, the proposed regulations do not appear to carry out the intent of Congress as reflected in the Conference report issued with the enactment of section 2704. This report stated that "these rules do not affect minority discounts or other discounts available under present law." However, it is hard to read these proposed regulations and determine that they are about anything other than "affecting minority discounts or other discounts available under present law"!

TIA also emphasized the concern that the proposed regulations would make valuations more difficult by requiring two appraisals, one of which would artificially inflate the value of a family-owned business. One appraisal would reflect the real fair market value of the business and one would reflect the artificially higher inflated value for tax purposes. The second appraisal will be an additional expense only for family-owned businesses. TIA believes that there is simply no justification for requiring an appraiser to value an active family-owned business differently simply because it is family-owned.  The appraisers, in their comments, made it clear that, based upon the language of the proposed regulations, they would have no idea how to comply with them!

Another major concern raised by TIA is that one section of these proposed regulations adds a new "within 3 years of death" rule, ostensibly to prevent deathbed transfers. This rule would nullify transactions that occurred within 3 years of death. It could also have a retroactive effective date, making it the worst kind of regulation because a rule that didn't even exist at the time the transaction took place would now apply even though there was no way the family-owned business could have known the rule would even come into existence.  This illustrates Treasury's expansion into the legislative arena - one which TIA believes impermissibly exceeds Treasury's regulatory mandate under §2704(b)(4). TIA sees this proposed rule as one more trap for the unwary or the unlucky! 

Although TIA made it clear to the IRS that it believes that the proposed regulations should simply be withdrawn and not replaced, TIA urged that, in the event new proposed regulations are re-proposed instead of withdrawn, they should at a minimum (i) exempt all active family-owned businesses, (ii) require that appraisals be based on the real fair market value of the business and not on an inflated value engineered by the tax code, (iii) not include the new 3 years of death rule, and (iv) take no action which would adversely impact minority and lack of marketability discounts as they stood when section 2704 was enacted.  

 

700 Economist Support Death Tax Repeal

By: James Freeman

August, 2017- Wall Street Journal 

 

Just 11 years after his death, Milton Friedman is leading an expanding campaign to persuade lawmakers to abolish the federal estate tax. And this posthumous lobbying effort by the winner of the 1976 Nobel Prize in economics couldn't come at a better time.

Here's the story: Workers cannot earn higher wages unless they get more productive, and the bad news is that productivity growth still hasn't broken out of its Obama-era slump. Today the Journal reports:

Compared with a year earlier, which is how economists often look at the longer-term trend, productivity was up 1.2% in the second quarter. That was a pickup from last year, when productivity posted its first calendar-year decline since 1982. It also matched the average pace since 2007, but remained well below the post-World War II average of 2.1% annual growth.

Lacking faith in the economic future, business owners have been reluctant to invest in the equipment that makes workers more productive. And the difference for workers between productivity growing at its recent 1% per year versus the faster traditional rate is enormous:

"If labor productivity grows an average of 2% per year, average living standards for our children's generation will be twice what we experienced," Federal Reserve Vice Chairman Stanley Fischer said in a July speech. "If labor productivity grows an average of 1% per year, the difference is dramatic: Living standards will take two generations to double."

In the U.S., productivity growth was slowing before the recession began in December 2007 and has been historically weak throughout the recovery that began in mid-2009. That likely restrained wage growth and overall growth in economic activity.

A great way to encourage the investment that allows workers to be more productive and to command higher wages is to increase the returns on such investment. This column recently noted the voluminous research showing that reducing corporate income tax rates encourages investment which then drives wages higher for workers. Killing the federal estate tax, currently a whopping 40% after exemptions, would also encourage more investment-specifically in privately held businesses.

"Our model estimates that if you eliminated the estate tax the business capital stock would increase by 2.6 percent, which is about $850 billion worth of productive assets," says Kyle Pomerleau of the Tax Foundation.

Friedman championed death-tax repeal for years. And now, just in time for a congressional debate on tax reform, he has managed to persuade more economists to participate in the campaign than he ever could while he was alive. In 2001, Friedman wrote an open letter on the subject and convinced 276 other members of his profession to sign along with him. This week the Family Business Coalition will announce that the letter now bears the names of 723 economists, including four winners of the Nobel Prize. Here's the text of the letter, which makes eminent good sense even to those outside the economics profession:

To whom it may concern:

Spend your money on riotous living - no tax; leave your money to your children - the tax collector gets paid first. That is the message sent by the estate tax. It is a bad message and the estate tax is a bad tax.

The basic argument against the estate tax is moral. It taxes virtue - living frugally and accumulating wealth. It discourages saving and asset accumulation and encourages wasteful spending. It wastes the talent of able people, both those engaged in enforcing the tax and the probably even greater number engaged in devising arrangements to escape the tax.

The income used to accumulate the assets left at death was taxed when it was received; the earnings on the assets were taxed year after year; so, the estate tax is a second or third layer of taxation on the same assets.

The tax raises little direct revenue- partly because the estate planners have been so successful in devising ways to escape the tax. Costs of collection and compliance are high, perhaps of the same order as direct tax receipts. The encouragement of spending reduces national wealth and thereby the flow of aggregate taxable income. These indirect effects mean that eliminating the tax is likely to increase rather than decrease the net revenue yield to the federal government.

The estate tax is justified as a means of reducing the concentration of wealth. However, the truly wealthy and their estate planners avoid the tax. The low yield of the tax is a testament to the ineffectiveness of the tax as a force for reshaping the distribution of wealth.

The primary defense made for the estate tax is that it encourages charity. If so, there are better and less costly ways to encourage charity. Eliminating the estate tax will lead to higher economic growth, which is the most important variable in determining the level of charitable giving.

Death should not be a taxable event. The estate tax should be repealed.